Does FX Volatility Affect the Distributions of Commodity Futures Returns?

This paper employs a two-step GARCH-M procedure to study price and volatility spillover effects from a series of foreign exchange rate returns to CME Group commodities in the grains, livestock, and energy complexes. Exchange rates are purported to have supply and demand effects on commodity prices and we hypothesize that this translates into transmissions of distributional shocks from currency returns to commodity returns distributions. The currencies are segregated into three groups: large GDP economies and major US trade partners, emerging economies, and pacific rim countries. Our results show that exchange rates for the EU, Canada, Mexico, Brazil, and Australia have the strongest and broadest transmissions of mean innovations to the observed commodities. These are all either major trade partners with the US and/or major exporters of agricultural commodities. Volatility transmissions are much less pronounced and tend to occur for lower liquidity commodities. These results have implications for models considering asset pricing, price discovery, and hedging applications for commodity returns.