The effect of the US dollar exchange rate on oil prices: An oil financialization perspective

This study investigates the regime-specific relationship between the USD exchange rate and oil prices. We embed the threshold variables of structural breaks and oil financialization into the VAR model of the dollar-oil relationship. Using daily data from 1983 to 2022, we find that a marked structural change in the dollar-oil relation exists in 2001 and that deepening oil financialization drives the structural change, making the portfolio effect the dominant effect of the dollar on oil prices. After 2001, the dollar negatively affects oil prices in both the long and short run. Furthermore, our threshold regression based on the investor self-adaptive expectation model shows that investor expectations significantly affect the dollar-oil relationship under oil financialization. A sharp increase in USD exchange rate volatility would strengthen investors' unilateral expectation of the trend of the USD exchange rate, which further enhances the portfolio effect, resulting in an even stronger negative effect of the dollar on oil prices.