Volatility in Oil Prices and Manufacturing Activity: An Investigation of Real Options

26 Pages Posted: 15 Jan 2011 Last revised: 18 Feb 2013

See all articles by John Elder

John Elder

Colorado State University

Apostolos Serletis

University of Calgary - Department of Economics

Date Written: December 20, 2010

Abstract

Previous research shows that volatility in oil prices has tended to depress output, as measured by non-residential investment and GDP. This is interpreted as evidence in support of the theory of real options in capital budgeting decisions, which predicts that uncertainty about, for example, commodity prices, will cause firms to delay production and investment. We continue that investigation by analyzing the effect of oil price uncertainty on monthly measures of U.S. firm production related to industries in mining, manufacturing and utilities. We use a more general specification, an updated sample that includes the increased oil price volatility since 2008, and we control for other nonlinear measures of oil prices. We find additional empirical evidence in support of the predictions of real options theory, and our results indicate that the extreme volatility in oil prices observed in 2008 and 2009 contributed to the severity of the decline in manufacturing activity, consistent with the observations of policy makers.

Keywords: oil volatility, uncertainty, multivariate GARCH VAR, real options

JEL Classification: G31, E32, C32

Suggested Citation

Elder, John and Serletis, Apostolos, Volatility in Oil Prices and Manufacturing Activity: An Investigation of Real Options (December 20, 2010). Macroeconomic Dynamics, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1740627 or http://dx.doi.org/10.2139/ssrn.1740627

John Elder (Contact Author)

Colorado State University ( email )

Dept of Finance & Real Estate
1272 Campus Delivery
Fort Collins, CO 80523
United States
970-491-2952 (Phone)

HOME PAGE: http://lamar.colostate.edu/~jelder

Apostolos Serletis

University of Calgary - Department of Economics ( email )

2500 University Drive, NW
Calgary, Alberta T2N 1N4
Canada
403 220-4091 (Phone)
403 282-5262 (Fax)

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