Total, asymmetric and frequency connectedness between oil and forex markets

TL;DR

This paper investigates how oil and forex markets are interconnected across different frequencies and asymmetries using high-frequency data, revealing that shocks and policy regimes influence volatility spillovers and market connectedness.

Contribution

It introduces a novel approach combining variance decompositions, spectral analysis, and realized semivariances to analyze frequency and asymmetric connectedness between oil and forex markets.

Findings

Negative shocks dominate forex volatility connectedness.

Positive shocks are more influential when analyzing oil and forex jointly.

Uncertainty shocks significantly increase long-term connectedness during crises.

Abstract

We analyze total, asymmetric and frequency connectedness between oil and forex markets using high-frequency, intra-day data over the period 2007 -- 2017. By employing variance decompositions and their spectral representation in combination with realized semivariances to account for asymmetric and frequency connectedness, we obtain interesting results. We show that divergence in monetary policy regimes affects forex volatility spillovers but that adding oil to a forex portfolio decreases the total connectedness of the mixed portfolio. Asymmetries in connectedness are relatively small. While negative shocks dominate forex volatility connectedness, positive shocks prevail when oil and forex markets are assessed jointly. Frequency connectedness is largely driven by uncertainty shocks and to a lesser extent by liquidity shocks, which impact long-term connectedness the most and lead to its dramatic increase during periods of distress.