Risk, Uncertainty, World Business Cycles, and the U.S. Stock-Oil Relationship

Abstract

Following Knight’s distinction of risk versus uncertainty, we examine the transmission of geopolitical risks (GPR), VIX volatility, economic policy uncertainty (EPU), and “macro uncertainty” measures to real WTI oil and U.S. stock returns (S&P 500 and NASDAQ). To fill this research gap, we employ structural vector autoregressions (SVAR) to monthly data from 1990:M1 to 2023:M6. Using an identification strategy based on long-run restrictions of impulse responses, we report the following results. First, oil prices respond positively to shocks in GPR and to macro uncertainty in the short-run but not to shocks in VIX and EPU. Second, allowing feedback from uncertainty/risk to world industrial production (WIP), the type of uncertainty matters for real oil prices. Stock returns, however, respond negatively and longer to shocks in risk/uncertainty. Third, on the stock and oil nexus, S&P 500 move up with positive RWTI shocks for between 5 and 8 months, supporting favorable stock market reaction to oil price fundamentals.

Keywords: Economic Policy Uncertainty, Geopolitical Risks, Macro Uncertainty, Oil Prices, Stock Returns, VIX.