Commodity Currencies: Unpicking the Asymmetric Relationship between Commodity Prices and Exchange Rates

A strong co-movement between the currencies of commodity export-dependent economies and commodity prices has been established as a stylised fact. However, the nature of this relationship remains contested. We develop a simple but novel exchange rate model that incorporates two transmission channels through which commodity price shocks can impact the exchange rate: a terms-of-trade channel and a risk premium channel. The model is empirically tested allowing for possible asymmetries in the exchange rate adjustment over commodity price booms and busts. We take four commodity-dependent economies with de jure flexible exchange rate regimes, open capital accounts, and relatively mature financial markets as case studies: Brazil, Chile, Colombia, and South Africa. Our results confirm all four currencies as commodity currencies. We further find that short-run asymmetries in the exchange rate adjustment originate in the risk premium, while long-run asymmetries are likely explained by changes in the productive structure following a price boom.