Oil Price Dynamics and Currency-Hedging Behavior: Out-of-sample Appendix

In a recent paper, Agudze and Ibhagui (2019) showed that for Korea, a major crude oil importer, the dollar-won cross-currency basis tends to tighten when oil prices increase. They argued that this positive relation stems from importers’ increased propensity to currency-hedge, that is to buy the dollar forward, when oil prices are in a high regime. They estimated this high oil price regime to have a median lower bound of $55. Much below this bound, such as the sub $40 oil prices that are being observed in the market in recent times, they noted that this meant oil prices have transitioned to a low-price regime. Under this regime, they argued that the propensity for oil importers to currency-hedge becomes substantially diminished. As a result, the dollar-won basis no more bears a positive and significant relation with oil prices. Interestingly, under the low price regime, they found evidence that the relation turns negative, so that a rise in oil prices goes together with wider dollar-won basis rather than the tighter dollar-won basis documented under the high price regime.