1 MUKHRIZ IZRAF AZMAN AZIZ Lancaster University ESDS International Annual Conference 2009 30 th November 2009 Institute of Materials, London.

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MUKHRIZ IZRAF AZMAN AZIZ

Lancaster University

ESDS International Annual Conference 2009

30th November 2009Institute of Materials, London

The paper is about : Oil price fluctuations & its relationship with exchange rates

The instability in the oil market in recent years affect many sectors in the economy

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Evidence to link oil price fluctuations to changes in GDP [Hamilton (1986); Burbidge and Harrison (1984) and Rotenberg and Woodford (1996)]

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Less attention has been paid to the relationship between exchange rates and oil price fluctuations

The recent surge in oil prices till mid-2007 was followed by depreciation in the US dollar and other major currencies.

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The potential significance of the price of oil for exchange rate movements has been noted by, inter alia (Golub, 1983, Krugman, 1983)

Evidence of long run relationship between oil price & exchange rate -Lee and Ni (1995), Hooker (1996)

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IntroductionImpacts of oil price fluctuations differ

between oil importing and oil exporting countries

Oil price increase may lead to exchange rate appreciation in oil exporting countries (Korhonen and Juurikkala, 2009)

For oil importing countries , oil price increase may lead to exchange rate depreciation (Chen and Chen, 2007)

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To empirically estimate the impacts of oil price fluctuations on exchange rate between oil importing and oil exporting countries

To determine if the impacts oil price fluctuations differ between these two groups of countries

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qit = αi + β1idrrit + β2iroilt

where qit is real exchange ratewhere drrit is real int. rate diffwhere roilt is real oil price in US dollar

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Model to Estimate

The paper uses 8 countries consisting of 5 net oil importing countries and 3 net oil exporting countries

Data is monthly panel data from 1980:1 to 2008:11.

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Method and Data

• To estimate the long run impacts of oil price shocks on real exchange rate, the paper employs Pesaran (1999) Pooled Mean Group Estimator (PMG)

• Uses another two estimators for robustness check : MG and DFE

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Method and Data

• Estimation procedures involve 3 steps:• 1st - Perform panel unit root test –

testing for stationarity of the data• Not a normal practice in econometric

using panel data• But is necessary in this paper because

of time series nature of data

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Method and Data

• Estimation procedures involve 3 steps:• 2nd -Testing for panel cointegration –

determine if long run relationship exist

• 3rd -Estimating long run relationship using(PMG)

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Series in Level Null

Hyp.

Exc. Rate Oil Price Int. Rate. Dif

Levin, Lin and

Chu

Unit Root -0.46 (0.32) 1.15 (0.87) 2.89 (0.99)

Breitung t-stat Unit Root 0.17 (0.57) 3.33 (0.99) -2.43 (0.00)

Im, Pesaran &

Shin

Unit Root 0.00 (0.50) 2.17 (0.98) -1.95 (0.02)

ADF-Fisher Unit Root 11.86 (0.75) 3.01 (0.99) 24.40(0.08)

Hadri Z-stat Stationary 10.05 (0.00) 29.24 (0.00) 4.86 (0.00)

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Panel Unit Root Tests for Panel of All Countries

All variables are non-stationary at levels

Series in 1st Diff Null

Hyp.

Exc. Rate Oil Price Int. Rate. Dif

Levin, Lin and

Chu

Unit Root -4.40 (0.00) -52.51(0.00) -73.42 (0.00)

Breitung t-stat Unit Root 1.55 (0.93) -9.71 (0.00) -17.92 (0.00)

Im, Pesaran &

Shin

Unit Root -8.68 (0.00) -37.35 (0.00) -49.52 (0.00)

ADF-Fisher Unit Root 118.77 (0.00) 843.94 (0.00) 1038.81

(0.00)

Hadri Z-stat Stationary 0.07 (0.47) -2.34 (0.99) -1.59 (0.94)

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Panel Unit Root Tests for Panel of All Countries

• all variables are stationary after 1st difference

Null hypothesis: No

Cointegration

Statistics Probability

Panel of All

Countries

-3.15 0.00*

Net Oil Exporting

Countries

-1.28 0.09*

Net Oil Importing

Countries

-2.88 0.00*

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Kao (1999) Residual Cointegration Tests

*Evidence of cointegration is found in the data

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Hypothesized

No. of CE(s)

(from trace

test)

Prob. (from max-

eigen test)

Prob.

None 38.93 0.00* 41.23 0.00*

At most 1 12.12 0.74 12.09 0.74

Maddala & Wu (1999) Panel Coint. Test for Panel of All Countries

*Evidence of cointegration is found in the data

Dependent Var: Log Real Exch. Rate

Without Time Trend. One lag (1,1,1) With Time Trend. One lag (1,1,1)

MG PMG Hausman DFE MG PMG Hausman DFE

Convergence Coeff

-0.02* -0.01* -0.01* -0.02* -0.01* -0.01*

Long Run Coeff.

Log Oil Price

0.04 0.18* 0.00 0.04 0.05 0.21* 0.00 0.05

Int.Rate Diff.

-1.59 -5.41* -0.30 -1.70 -4.95* -0.38

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Panel of 8 Countries

Positive relationship : oil price increase leads to exc. rate depreciation

The paper finds evidence of positive relationship between oil price & exchange rate among oil importing countries ; i.e. increase in oil price exch. rate depreciation (weakening of currency)

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However, no evidence of negative oil price – exchange rate relationship is found for oil exporting countries: i.e oil price increase leads to exchange rate appreciation

Perhaps the lack of evidence for oil exporting countries is due to selection of countries in the sample

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Mainly, the oil exporting countries are not main OPEC countries where oil account for major export contribution

Interest rate differential is negatively significant for all country groupings.

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