Explaining the Nonlinear Response of Stock Markets to Oil Price Shocks

45 Pages Posted: 24 Nov 2020 Last revised: 13 Dec 2020

See all articles by Diego Escobari

Diego Escobari

University of Texas - Pan American - College of Business Administration - Department of Economics & Finance; Texas A&M University - Department of Economics

Shahil Sharma

Texas A&M University (TAMU) - San Antonio

Date Written: July 11, 2020

Abstract

This paper is set to reconcile the existent conflicting empirical evidence on the effect of oil prices on stock prices. We estimate various nonlinear models where the response changes according to a first-order Markov switching process. More importantly, we model the transition probabilities between the high- and low-response regimes to depend on state variables to allow us to explain the forces behind the asymmetry in the response. The results show statistically significant asymmetries that can be explained by economic recessions and to a lower extent depend on the magnitude of the oil price shift and on whether the shift is positive or negative. In the high response regime, the effect is positive and lasts longer. We also find evidence of asymmetries in the response of stock prices to crude oil supply shocks, global aggregate demand shocks, and oil-specific demand shocks.

Keywords: Asymmetric effects, Recession, Stock, Oil shocks, Regime-switching

JEL Classification: C32, E32, G10, Q41

Suggested Citation

Escobari, Diego and Sharma, Shahil, Explaining the Nonlinear Response of Stock Markets to Oil Price Shocks (July 11, 2020). Available at SSRN: https://ssrn.com/abstract=3708115 or http://dx.doi.org/10.2139/ssrn.3708115

Diego Escobari

University of Texas - Pan American - College of Business Administration - Department of Economics & Finance ( email )

1201 W. University Drive
Edinburg, TX 78539-2999
United States

HOME PAGE: http://faculty.utrgv.edu/diego.escobari

Texas A&M University - Department of Economics ( email )

5201 University Blvd.
College Station, TX 77843-4228
United States

Shahil Sharma (Contact Author)

Texas A&M University (TAMU) - San Antonio ( email )

One University Way
San Antonio, TX 78224
United States

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