The short-run and long-run dynamics of oil prices and real exchange rates

This paper examines the empirical relationship between the real exchange rate and oil prices. It explores whether oil prices have a reliable out-of-sample relationship with real exchange rates using monthly data spanning the period of 1995-2015. In particular, the main objective is to know how well oil prices (on its own without other determinants) can predict the real exchange rates out-of-sample compared to the random walk benchmarks. The study adopts an error correction model (ECM) renowned for its ability to capture the short-run and long-run dynamics in a unified system. The empirical findings propose that the out-of-sample predictive ability is strong and robust across short-run horizons for South Korea and the long-run horizon for Kenya.