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Non-linear effects of oil shocks on stock prices

Author

Listed:
  • Haroon Mumtaz

    (Queen Mary University of London)

  • Ahmed Pirzada

    (University of Bristol)

  • Konstantinos Theodoridis

    (Cardiff Business School)

Abstract

This paper uses a panel Threshold VAR model to estimate the regime-dependent impact of oil shocks on stock prices. We find that an adverse oil supply shock has a negative effect on stock prices when oil inflation is low. In contrast, this impact is negligible in the regime characterised by higher oil price inflation. Using a simple DSGE model, we suggest that the explanation for this result may be tied to the behaviour of credit spreads. When oil inflation is low, lower policy rates encourage firms to get highly leveraged. A negative oil shock in this scenario leads to a substantial increase in spreads, reducing profits and equity prices. In contrast, at higher rates of inflation, spreads are less affected by the oil shock, ameliorating the impact on the stock market.

Suggested Citation

  • Haroon Mumtaz & Ahmed Pirzada & Konstantinos Theodoridis, 2018. "Non-linear effects of oil shocks on stock prices," Working Papers 865, Queen Mary University of London, School of Economics and Finance.
    • Handle: RePEc:qmw:qmwecw:865
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    File URL: https://www.qmul.ac.uk/sef/media/econ/research/workingpapers/2018/wp865.pdf
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    References listed on IDEAS

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    1. Marta Banbura & Domenico Giannone & Lucrezia Reichlin, 2010. "Large Bayesian vector auto regressions," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 25(1), pages 71-92.
    2. Marta Bańbura, 2008. "Large Bayesian VARs," 2008 Meeting Papers 334, Society for Economic Dynamics.
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    Cited by:

    1. De Santis, Roberto A. & Tornese, Tommaso, 2023. "Energy supply shocks’ nonlinearities on output and prices," Working Paper Series 2834, European Central Bank.
    2. Arampatzidis, Ioannis & Dergiades, Theologos & Kaufmann, Robert K. & Panagiotidis, Theodore, 2021. "Oil and the U.S. stock market: Implications for low carbon policies," Energy Economics, Elsevier, vol. 103(C).

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    More about this item

    Keywords

    Threshold VAR; Hierarchical Prior; DSGE model; Oil shocks;
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