Do Exchange Rates Matter?*

Oil prices have experienced large fluctuations in recent years.  The spike in crude oil prices in mid-2008 to more than $140/bbl, followed by a steep correction in late 2008/early 2009 and subsequent sharp rebound over the last two years have jolted the world economy and pinched consumers at the fuel pump. US dollar weakness in recent years is frequently cited as one reason for high oil prices. It is very common to see the financial press suggesting that a weak dollar has pushed oil prices higher. However, this explanation is challenged by the empirical observations that (a) a change in oil price tends to lead to a change in the exchange rate as predicted by economic theory and (b) the oil price has risen regardless of what currency unit one uses to measure the price of oil.

Commodities: No Longer an Asset Class in their Own Right?*

Investors, seeking to diversify their portfolio and hedge against rising inflation, have increased their exposure to commodities by directly purchasing commodities, by taking outright positions in commodity futures, or by acquiring stakes in exchange-traded commodity funds (ETFs) and in commodity index funds. This pattern has accelerated in recent years. According to index investment data collected by Barclays Capital for US and non-US assets under management, commodity index investment has increased from $55 billion in late 2004 to $431 billion in July 2011.

Exchange Rates and Oil Prices*

US dollar weakness in recent years is frequently cited as one reason for high oil prices. It is very common to see the financial press suggesting that a weak dollar has pushed oil prices higher. Empirically, there is clearly an inverse correlation between oil prices and exchange rates – that is, other things being equal, oil prices rise if the dollar falls. An assessment of the dynamic conditional correlation (DCC) and of the one-year rolling average correlation between the daily change in the oil price and the daily change in the nominal effective exchange rate shows that this relationship has been relatively strong in recent years, although the negative correlation has been declining in recent months. What is less clear, though, is the direction of causality. Several econometric techniques suggest that causality may run from the oil price to the exchange rate, rather than the opposite.

Does “Paper Oil” Matter? Energy Markets’ Financialization and Equity-Commodity Co-Movements

My coauthor Michel Robe and I presented our new research paper, entitled "Does 'Paper Oil' Matter? Energy Markets’ Financialization and Equity-Commodity Co-Movements", at Universidad Carlos III in Madrid on May 25 and at the ISTCE Business School's Annual Conference on Commodities and Energy Markets in Lisbon on May 27, 2011. 

Abstract:

We construct a uniquely detailed, comprehensive dataset of trader positions in U.S. energy futures markets.  We identify considerable changes in the make-up of the open interest between 2000 and 2010 and show that these changes impact asset pricing.  Specifically, dynamic conditional correlations between the rates of return on investable energy and stock market indices increase significantly amid greater activity by speculators in general and hedge funds in particular (especially, funds active in both equity and energy markets).  The impact of hedge fund activity is markedly lower in periods of financial market stress.  Our results support the notion that the composition of trading activity in futures markets helps explain an important aspect of the distribution of energy returns, and have ramifications in the debate on the financialization of energy markets.