Dynamic connectedness of oil price shocks and exchange rates

Highlights: • We use novel method of isolating the oil price shocks using daily data. • We study the impact of oil shocks on exchange rates for major oil-dependent countries. • Results show that demand shocks have a major impact while supply shocks have no impact. • Connectedness between oil price shocks and exchange rates has increased since financial crisis. • Our findings have important implications for policy makers and financial market participants. -- Abstract: Using a novel method of isolating the oil price shocks, we study how different sources of oil price shocks are connected to exchange rates of major oil-dependent countries using daily data from March 1996 to February 2019. We find that oil price shocks resulting from changes in demand and risk significantly contribute to variation in exchange rates, while supply shocks have virtually no impact. The connectedness of this relationship between oil price shocks and exchange rates has significantly increased after the global financial crisis. We also find that oil price shocks do not explain the variation in exchange rate volatility but we document significant volatility connectedness among exchange rates. Our findings have important implications for policy makers and financial market participants.