Abstract
Geopolitical factors are considered a crucial factor that makes a difference in crude oil prices. Over the last three decades, many political events occurred frequently, causing short-term fluctuations in crude oil prices. This paper aims to examine the dynamic correlation and causal link between geopolitical factors and crude oil prices based on data from June 1987 to February 2020. By using a time-varying copula approach, it is shown that the correlation between geopolitical factors and crude oil prices is strong during periods of political tensions. The GPA (geopolitical acts) index, as the real factor, drives the rise in prices of crude oil. Moreover, the dynamic correlation between geopolitical factors and crude oil prices shows strong volatility over time during periods of political tensions. We also found unidirectional causality running from geopolitical factors to crude oil prices by using the Granger causality test.
Highlights
This paper examines the dynamic correlation and causality between geopolitical factors and crude oil prices in different political environments
This shows that the ARIMA(1, 1, 2) − GARCH(1, 1) model is suitable for fitting the marginal distribution of the geopolitical risk (GPR), geopolitical threats (GPT), geopolitical acts (GPA), Brent and West Texas Intermediate (WTI) series
The parameters α and β of the GARCH model were statistically significant for all series, which shows that GPR, GPT, BRENT and WTI all have a volatility clustering effect
Summary
This paper examines the dynamic correlation and causality between geopolitical factors and crude oil prices in different political environments. There are many studies discussing the impact of extreme political acts on crude oil prices [1,2,3,4], we use the GPR (geopolitical risk) index and its sub-indices, GPT (geopolitical threats), and GPA (geopolitical acts), constructed by Caldara and Iacoviello [5], Brent and West Texas Intermediate (WTI) to study the dynamic correlation between geopolitical relations (tense and moderate) and crude oil prices (see Appendix A for an explanation of the nomenclatures). This study further examines whether there is a causality between geopolitical factors and crude oil prices. To the best of our knowledge, this is the first time that the GPR index is used to examine causality between geopolitical factors and crude oil prices. The background and importance of this study are that international crude oil prices are always closely related to extreme political events. With the global spread of the COVID-19 virus in 2020, demand for crude oil has been hit hard, and international crude oil prices have fallen off a cliff since
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