Oil and foreign exchange market tail dependence and risk spillovers for MENA, emerging and developed countries: VMD decomposition based copulas

- The paper examines systemic risk and dependence structures between oil and 25 currency markets.
- We employ the Diebold-Yilmaz index, multiresolution and copula approaches.
- We quantify short- and medium-run up and down risk spillovers using the CoVaRs.
- We find average and tail dependence between oil and currencies which varies under time horizons.
- We provide evidence of higher risk spillovers in the medium- than short-run investment horizons.

This paper examines the short- and medium run dependence structures between oil and currency markets for MENA, other developing and developed countries, using a novel multiresolution decomposition method, namely the variational mode decomposition (VMD), along with a battery of time-invariant and time-varying symmetric and asymmetric copula functions. Further, we assess the downside and upside short- and medium-run risk spillovers from oil to U.S. exchange rate returns and vice versa by computing the conditional Value-at-Risk (CoVaR) risk measures. Before the copula estimations, we apply the spillover index of Diebold and Yilmaz (2012) and network diagrams to identify and select the currencies that are the most significant net contributors or net receivers of returns from/to the oil/currency markets. The copula results show strong evidence of time-varying and high average (tail) dependence between oil returns and the FX markets, which are net transmitters to oil, for the short and medium time horizons. On the other hand, we find average and relatively low dynamic dependence between oil and the net receiver currencies, regardless of the time horizons. Moreover, there is evidence of up and down risk asymmetric systemic risks from oil to currencies and vice versa for some countries in the short-and medium run horizons. Finally, the risk spillovers are asymmetric over time and investment horizons. These results have several important implications for hedging strategies and diversification benefits for oil and FX traders and institutional investors.