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Oil price volatility and the US stock market

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  • Sajjadur Rahman

    (Texas A&M University-San Antonio)

Abstract

In this paper, we investigate the relationship between oil price volatility and US real stock returns using a multivariate framework in which a structural vector autoregression (SVAR) is modified to accommodate the effects of stochastic volatility (SV) in oil prices on stock returns. Our measure of oil price volatility is the conditional variance of the oil price change forecast error. We isolate the effects of volatility in the change in the price of oil on real stock returns and calculate the dynamic responses of stock returns to a shock to oil price volatility. We find evidence that increased oil price volatility has a negative effect on US real stock returns. We support our evidence with the transmission mechanism that details on how the effects of oil price volatility shocks might be channeled into the stock market. Our results remain unchanged in the context of the disaggregate returns for a number of industry portfolios, suggesting that investors should consider oil price volatility in addition to other potential factors that affect stock returns.

Suggested Citation

  • Sajjadur Rahman, 2021. "Oil price volatility and the US stock market," Empirical Economics, Springer, vol. 61(3), pages 1461-1489, September.
    • Handle: RePEc:spr:empeco:v:61:y:2021:i:3:d:10.1007_s00181-020-01906-3
    DOI: 10.1007/s00181-020-01906-3
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    More about this item

    Keywords

    Crude oil; Stochastic volatility; Structural vector autoregression;
    All these keywords.

    JEL classification:

    • C3 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • G1 - Financial Economics - - General Financial Markets

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