Oil price shocks,global financial markets and their connectedness

This paper extends the literature on the relationship between oil price shocks and financial markets by examining the effect of oil shocks on the sovereign bond markets of a large number of advanced and emerging economies and exploring the impact of oil shocks on the degree of connectedness among international financial markets. We show that the effect of oil price shocks is not only limited to stock market returns, but also extends to bond markets, even after controlling for discount rate shocks as well as aggregate capital market effects. Unlike the case for stock markets, the effect on sovereign bonds is found to be rather heterogeneous (in terms of size and sign) and primarily driven by demand related shocks. We also show that oil price shocks serve as a driver of connectedness patterns across global financial markets, although the effect on connectedness depends on the nature of the oil market shock and the economic characteristics of the countries. Overall, the findings highlight the role of crude oil as a driver of not only of return dynamics in global stock and bond markets, but also of global financial connectedness patterns.     

Dynamic connectedness of oil price shocks and exchange rates

Using a novel method of isolating the oil price shocks, we study how different sources of oil price shocks are connected to exchange rates of major oil-dependent countries using daily data from March 1996 to February 2019. We find that oil price shocks resulting from changes in demand and risk significantly contribute to variation in exchange rates, while supply shocks have virtually no impact. The connectedness of this relationship between oil price shocks and exchange rates has significantly increased after the global financial crisis. We also find that oil price shocks do not explain the variation in exchange rate volatility but we document significant volatility connectedness among exchange rates. Our findings have important implications for policy makers and financial market participants.     

The impacts of structural oil shocks on macroeconomic uncertainty: Evidence from a large panel of 45 countries

Using local projection methods, this paper employs monthly panel data from 1989 to 2017 to examine both linear and nonlinear impulse responses of macroeconomic uncertainty to structural shocks to global oil production, aggregate demand, oil-market-specific demand and speculative demand in a large group of 45 economies. We find that both oil supply and demand shocks are important drivers of uncertainty. There is strong evidence that the impacts of oil price shocks on macroeconomic uncertainty are regime-dependent and contingent on the states of investor sentiments and perceived volatility in financial markets. The responses of economic uncertainty to oil shocks, especially demand-side shocks, appear to experience a dramatic change in the post-Global Financial Crisis period.     

Oil shocks and stock markets revisited: Measuring connectedness from a global perspective

This paper contributes to the large volume of empirical studies on the relationship between oil shocks and stock markets from a new systemic perspective. The method of measuring connectedness proposed by Diebold and Yilmaz (2009, 2012, 2014) is adopted to study the relationship between oil shocks and returns at six major stock markets around the world. It is shown that the contribution of oil shocks to the world financial system is limited. Oil price changes, however, can be explained by information on the financial system. Furthermore, a rolling windows analysis finds that oil shocks can occasionally contribute significantly to stock markets, and it is also proved that only large shocks matter.     

Which oil shocks really matter in equity markets?

This paper examines the relationship between structural oil shocks and US equity markets. The recent oil shock decomposition of Ready (2018) is reconsidered and refined, providing a clearer delineation between shocks to equity market discount rates and aggregate demand, leading to an oil shock specification which attributes substantially more explanatory power to the latter in explaining equity market variation. Providing links with the literature dating back to Kilian and Park (2009), an explicit role is given to precautionary demand shocks using an independent measure constructed from oil futures data, reducing the role of the supply shocks obtained as the final residual in the recursive identification scheme. In an extended sample that allows an analysis of the oil/equity market relationship since the global financial crisis, the modified aggregate demand shocks have approximately twice as much explanatory power for stock return variation than the demand shocks of Ready (2018). The importance of these shocks in driving oil price changes and equity market volatility has only increased since the financial crisis, with the role of supply shocks diminishing. Once these demand effects are accounted for, there is little relationship between precautionary demand shocks and equity returns, in contrast to the existing literature.     

Time and frequency connectedness among oil shocks,electricity and clean energy markets

This paper examines the time and frequency connectedness among electricity, carbon and clean energy markets, and oil price demand and supply shocks. In doing so, we use the spillover method proposed by Diebold and Yilmaz (2012) and its extension in the frequency domain by Baruník and Křehlík (2018). We find increased connectedness during the global financial crisis as well as in the shale oil revolution period. The total connectedness is also higher in the short-run compared to the long-run. Due to their low connectedness, electricity futures can act as a risk diversifier and safe-haven asset against oil shocks. Net pairwise directional connectedness among oil shocks and the clean energy index is higher during the shale oil revolution. These results have important implications for investors with different investment time horizons.     

Assessing the impact of US ethanol on fossil fuel markets: A structural VAR approach

Despite the growing importance of biofuels, the effect of biofuels on fossil fuel markets is not fully understood. We develop a joint structural Vector Auto Regression (VAR) model of the global crude oil, US gasoline, and US ethanol markets to examine whether the US ethanol market has had any impact on global oil markets. The structural VAR approach provides a unique method for decomposing price and quantity data into demand and supply shocks, allowing us to estimate the distinct dynamic effects of ethanol demand and supply shocks on the real prices of crude oil and US gasoline. Ethanol demand in the US is driven mainly by government support in the form of tax credits and blending mandates. Shocks to ethanol demand therefore reflect changes in policy more than any other factor. In contrast, ethanol supply shocks are driven by changes in feedstock prices. A principle finding is that a policy-driven ethanol demand expansion causes a statistically significant decline in real crude oil prices, while an ethanol supply expansion does not have a statistically significant impact on real oil prices. This suggests that even though US ethanol market is small, the influence of US biofuels policy on the crude oil market is pervasive. We also show that ethanol demand shocks are more important than ethanol supply shocks in explaining the fluctuation of real prices of crude oil and US gasoline.     

Crude oil,equity and gold futures open interest co-movements

The study is unique in its investigation of the co-movements between trading activity on the equity, crude oil, and gold futures market, proxied by open interest. It provides empirical evidence that stock and crude oil futures demand for hedging is positively related, but reacts negatively to sudden shocks in open interest on the other market. Furthermore, gold futures open interest reacts positively to shocks in the crude oil futures trading activity. The level of instantaneous linkage is related to external market conditions. During periods of unstable financial markets, the correlation between equity and energy futures open interest decreases, and the correlation of the open interest on the equity and gold futures market turns weak negative. This indicates hedging funds allocation toward gold market in periods of stock market uncertainty.     

The effects of oil price shocks on output and inflation in China

Crude oil price shocks derive from many sources, each of which may bring about different effects on macro-economy variables and require completely different designs in macro-economic policy; thus, distinguishing the sources of oil price fluctuations is crucial when evaluating these effects. This paper establishes an open-economy dynamic stochastic general equilibrium (DSGE) model with two economies: China and the rest of the world. To assess the effects of oil price shocks, the CES production function is extended by adding oil as an input. Based on the model, the effects of four types of oil price fluctuations are evaluated. The four types of oil price shocks are supply shocks driven by political events in OPEC countries, other oil supply shocks, aggregate shocks to the demand for industrial commodities, and demand shocks that are specific to the crude oil market. Simulation results indicate the following: Oil supply shocks driven by political events mainly produce short-term effects on China's output and inflation, while the other three shocks produce relatively long-term effects; in addition, demand shocks that are specific to the crude oil market contribute the most to the fluctuations in China's output and inflation.     

Global connectedness of MSCI energy equity indices: A system-wide network approach

The paper utilizes MSCI energy indices of 21 major energy consumer economies as a full sample to serve as a proxy indicator of the energy sector of these economies and then studies the squared return spillover interlinkages among them for the pre- and post-global financial crisis of 2008 and during the crude oil crises of 2008–09 and 2014–15. The squared return spillover connectedness has been analyzed on intra- and inter-regional basis based on the segregation of indices into regions, viz., Europe, North and Latin America, and Asia Pacific and Africa. The connectedness interlinkage has been quantified deploying Generalized Error Variance Decomposition (GEVD), and the results have been visualized via network diagrams. The result shows that the return spillover connectedness is significant and is more prominent in some economies, primarily in Europe and North America, for the full sample. However, post-crisis, the squared return spillover connectedness of emerging economies of Asia Pacific has witnessed a boost. Surprisingly, Russia, as a major oil exporter, sends moderate shocks system-wide in the post-crisis era, implying economic sanctions downplay the influence it could make in the energy sector. During the crisis year, though spillover risk transmission is high during the 2008–09 crisis, it is more spread out during the 2014–15 crisis with the inclusion of the Asia Pacific emerging market energy indices.     

Time-varying co-movements between energy market and global financial markets: Implication for portfolio diversification and hedging strategies

This study explores the time patterns of volatility spillovers between energy market and stock prices of seven major global financial markets including clean energy, energy, information technology corporations, equity markets and United States economic policy index over the period vary from December 28, 2000 to December 31, 2018. We employ a time domain connectedness measures of Diebold and Yilmaz (DY, 2009, 2012 and 2014) to examine spillover mechanism of volatility shocks across future markets. Optimal weights and hedge ratios are calculated for portfolio diversification and risk management. The main findings of the study conclude that oil shocks are exogenous and contribution of oil market volatility to global financial markets is insignificant. The returns of World Stock Index and World Energy Index are major transmitters of volatility to clean energy market. Moreover, the impact of energy market become strong in global financial market when data is divided into pre, during and post financial crisis periods. Finally, the hedge ratios are volatile over time and their maximum value is observed during the financial crisis period of 2008–09. The optimal portfolio between energy and stock prices are heavily weighted to the stock markets.     

Linkages between oil price shocks and stock returns revisited

In this paper, we revisit the debate on the relationship between oil price shocks and stock market returns by replicating the quantile-on-quantile (QQ) regression model for the US stock market in Sim and Zhou (2015, Journal of Banking and Finance), and extending it to 15 countries. The classification of these countries as oil importers or oil exporters depends on their net position in crude oil trade. Our results indicate that the main finding by Sim and Zhou (2015) that large negative oil price shocks can bolster stock returns when markets are performing well is only partially supported by the three largest oil importers in our sample – China, Japan and India – during the period 1988:1–2007:12. However, when extending the study to more recent data (period 1988:1–2016:12), we find that China and India experience higher returns when markets perform well and there is a large positive oil price shock. Also, large positive oil price shocks often lead to higher stock market returns when markets perform well for both oil exporting countries – Canada, Russia, Norway – and moderately oil dependent countries – such as Malaysia, Philippines and Thailand. In most cases large negative oil price shocks depress further already poorly performing markets, as in Sim and Zhou (2015). These findings highlight that the relationship between the distributions of oil price shocks and stock market returns is not stable over time in most countries studied. Furthermore, the asymmetric effect between positive and negative oil price shocks observed in the US market by Sim and Zhou (2015) is less evident in most countries for both the baseline and extended periods.     

Oil prices,fundamentals and expectations

This paper empirically investigates the relationship between oil prices, traditional fundamentals and expectations. Informational frictions may force a wedge between oil prices and supply and/or demand shocks, especially during periods of elevated risk aversion and uncertainty. In such a context, expectations can be a key driver of oil price movements and their impact can vary over time. Overall, we find that both traditional oil fundamentals and forward-looking expectations matter for oil prices. Our findings show that the real price of oil responds differently to expectations shocks of business leaders, consumers and aggregate markets. Our TVP-VAR approach provides evidence that business leaders' expectations play an important role in terms of oil price fluctuations and the impact is stronger in periods of elevated global oil demand. In terms of traditional oil market fundamentals, we find that oil prices have been significantly affected by the recent US shale oil boom. Moreover, global oil demand had a positive impact upon oil prices, especially from the mid-2000s. Several alternative model specifications prove the robustness of our analysis.     

Cyclical properties of supply-side and demand-side shocks in oil-based commodity markets

Oil markets profoundly influence world economies through determination of prices of energy and transports. Using novel methodology devised in frequency domain, we study the information transmission mechanisms in oil-based commodity markets. Taking crude oil as a supply-side benchmark and heating oil and gasoline as demand-side benchmarks, we document new stylized facts about cyclical properties of the transmission mechanism generated by volatility shocks with heterogeneous frequency responses. Our first key finding is that shocks to volatility with response shorter than one week are increasingly important to the transmission mechanism over the studied period. Second, demand-side shocks to volatility are becoming increasingly important in creating short-run connectedness. Third, the supply-side shocks to volatility resonating in both the long run and short run are important sources of connectedness.     

The effects of oil price shocks on Asian exchange rates: Evidence from quantile regression analysis

This paper investigates the effects of oil price shocks on Asian exchange rates. We employ quantile regression analysis and allow for structural breaks and asymmetry. Our results indicate that positive and negative oil price shocks have asymmetrical effects on exchange rate returns that vary in significance, size, and sign throughout the distribution of exchange rate returns. The impact of oil price shocks is also affected by market conditions (bearish and bullish currency markets). During bullish markets in domestic currencies, (at lower quantiles of currency movements in terms of U.S. dollar exchange rates), rising oil prices cause further appreciation for Indonesia, Korea, the Philippines, and Thailand currencies. During bearish markets in the domestic currencies (at higher quantiles of exchange rate movements in terms of U.S. dollar exchange rates), rising (falling) oil price causes further currency depreciation for Indonesia (Malaysia). Thus, currencies respond differently to oil price shocks under extreme bullish or bearish currency market conditions and the impact of rising or falling oil prices on foreign exchange markets can vary by country and market conditions.     

The effect of global oil price shocks on China's metal markets

This paper investigated the impacts of global oil price shocks on the whole metal market and two typical metal markets: copper and aluminum. We applied the autoregressive conditional jump intensity (ARJI) model, combining with the generalized conditional heteroscedasticity (GRACH) method, to describe the volatility process and jump behavior in the global oil market. We separated the oil price shocks into positive and negative parts, to analyze whether oil price volatility had symmetric impacts on China’s metal markets. We further used the likelihood ratio test to examine the symmetric effect of oil price shocks. In addition, we considered the jump behavior in oil prices as an input factor to investigate how China’s metal markets are affected when jumps occur in the global oil market, in contrast to the existing research paying little attention to this issue. Our results indicate that crude oil price shocks have significant impacts on China's metal markets and the impacts are symmetric. When compared with aluminum, copper is more easily affected by oil price shocks.     

Oil price shocks and agricultural commodity prices

While the impacts of oil price changes on agricultural commodity markets are of great interest to economists, previous studies do not differentiate oil-specific shocks from aggregate demand shocks. In this paper, we address this issue using a structural VAR analysis. Our findings indicate that the responses of agricultural commodity prices to oil price changes depend greatly on whether they are caused oil supply shocks, aggregate demand shocks or other oil-specific shocks mainly driven by precautionary demand. Oil shocks can explain a minor friction of agricultural commodity price variations before the food crisis in 2006–2008, whereas in post-crisis period their explanatory abilities become much higher. After crisis, the contributions of oil-specific factors to variations in agricultural commodity prices are greater than those of aggregate demand shocks. The results from an alternative SVAR confirm the robustness of our main findings.     

Empirical evidence of news about future prospects in the risk-pricing of oil assets

This empirical paper investigates the relevance of long-run risks associated with uncertainty shocks to future growth prospects (news about future prospects) for explaining the risk-pricing of oil stocks. An econometric method that incorporates dynamic factor analysis is used for estimating the pricing equation of oil stocks. The results indicate that oil investors care about long-run risks associated with future growth prospects. Long-run risks account for almost half of the total risk-premium of oil stocks. Long-run risks associated with future growth prospects are significantly shaped by latent factors related to the labor market, the price indices, and financial markets. Moreover, our estimated model captures some historical events including the oil crisis of the seventies, the economic crisis of the mid-eighties, the stock market crash of 1987, and the economic crises of 1998 and 2000.     

How does oil price volatility affect non-energy commodity markets?

The influence of price volatility in the crude oil market is expanding to non-energy commodity markets. With the substitution of fossil fuels by biofuel and hedge strategies against inflation induced by high oil prices, the link between crude oil market and agriculture markets and metal markets has increased. This study measures the influence of the crude oil market on non-energy commodity markets before and after the 2008 financial crisis. By introducing the US dollar index as exogenous shocks, we investigate price and volatility spillover between commodity markets by constructing a bivariate EGARCH model with time-varying correlation construction. The results reveal that the crude oil market has significant volatility spillover effects on non-energy commodity markets, which demonstrates its core position among commodity markets. The overall level of correlation strengthened after the crisis, which indicates that the consistency of market price trends was enhanced affected by economic recession. In addition, the influence of the US dollar index on commodity markets has weakened since the crisis.     

Does the U.S. economic policy uncertainty connect financial markets? Evidence from oil and commodity currencies

We provide novel insight to the emerging literature on the role of U.S. monetary policy as a driver of a global financial cycle by examining the possible causal effect of U.S. economic policy uncertainty on the connectedness of crude oil and currency markets, using a sample of commodity currencies from advanced and emerging nations. A battery of linear and nonlinear Granger-based causality tests indicate the presence of a causal relationship between economic policy uncertainty and the connectedness of oil and currency markets, particularly at low frequencies and more significantly after the outburst of the global financial crisis. While crude oil generally serves as a net transmitter of shocks to currencies across all frequency bands, the spillover effects from oil are largely concentrated towards the G10 currencies of Australian and New Zealand dollar that are often used as investment currencies in global carry trade strategies. Overall, our findings suggest the presence of a significant pass-through effect of economic policy uncertainty via oil prices, spilling over to the currency market, in line with the emerging evidence that the monetary policy by the U.S. Fed serves as a major driver of a global financial cycle that describes patterns in global capital flows, credit activity and asset prices across financial markets.