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The causal nexus between oil prices and equity market in the U.S.: A regime switching model

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  • Balcilar, Mehmet
  • Ozdemir, Zeynel Abidin

Abstract

The aim of this paper is to analyse the causal link between monthly oil futures price changes and a sub-grouping of S&P 500 stock index changes. The causal linkage between oil and stock markets is modelled using a vector autoregressive model with time-varying parameters so as to reflect changes in Granger causality over time. A Markov switching vector autoregressive (MS-VAR) model, in which causal link between the series is stochastic and governed by an unobservable Markov chain, is used for inferring time-varying causality. Although we do not find any lead–lag type Granger causality, the results based on the MS-VAR model clearly show that oil futures price has strong regime prediction power for a sub-grouping of S&P 500 stock index during various sub-periods in the sample, while there is a weak evidence for the regime prediction power of a sub-grouping of S&P 500 stock indexes. The regime-prediction non-causality tests on the MS-VAR model show that both variables are useful for making inference about the regime process and that the evidence on regime-prediction causality is primarily found in the equation describing a sub-grouping of S&P 500 stock market returns. The evidence from the conditional non-causality tests shows that past information on the other series fails to improve the one step ahead prediction for both oil futures and stock returns.

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Bibliographic Info

Article provided by Elsevier in its journal Energy Economics.

Volume (Year): 39 (2013)
Issue (Month): C ()
Pages: 271-282

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Handle: RePEc:eee:eneeco:v:39:y:2013:i:c:p:271-282

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Web page: http://www.elsevier.com/locate/eneco

Related research

Keywords: Oil price; Equity markets; Markov-switching model; Time-varying Granger causality;

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References

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Cited by:
  1. Beckmann, Joscha & Czudaj, Robert, 2013. "Is there a homogeneous causality pattern between oil prices and currencies of oil importers and exporters?," Energy Economics, Elsevier, vol. 40(C), pages 665-678.
  2. Krenar Avdulaj & Jozef Barunik, 2013. "Are benefits from oil - stocks diversification gone? A new evidence from a dynamic copulas and high frequency data," Papers 1307.5981, arXiv.org.

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