The impact of export commodity prices, which are essentially exogenous, on the AUD/USD exchange rate is investigated. We use a Markov Regime Switching model to identify significant structural breaks endogenously. In this framework, the effect of four commodity sub-indices as generally favoured by the Reserve Bank of Australia is explored. These are Rural, Non-Rural, Base Metal and Bulk Commodities. The aim is to find, if any, state contingent explanatory power of these sub-indices on the changes in exchange rate. All the sub-indices have significant explanatory power during low volatility regime. But during high volatility regime only the first two sub-indices are significant. Further investigation reveals that a large jump in the Bulk Commodity sub index up or down may indeed be followed by a regime shift. The model also identifies the post GFC period as the high volatility state.
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