Effect of rare disaster risks on crude oil: evidence from El Niño from over 145 years of data

Abstract

We extend the literature on the effect of rare disaster risks on commodities by examining the effect of the El Niño-Southern Oscillation (ENSO) on crude oil via the recently developed kth order nonparametric causality-in-quantile framework, utilizing a long-range historical data set spanning the period 1876:01 to 2021:04. The methodology allows us to test for the predictive role of ENSO over the entire conditional distribution of not only real oil returns but also its volatility, by controlling for misspecification due to uncaptured nonlinearity and regime changes. Empirical findings show that the Southern Oscillation Index (SOI), measuring the ENSO cycle, not only predicts real West Texas Intermediate (WTI) oil returns of the United States (US), but also volatility, over the entirety of the respective conditional distributions. The findings highlight the role of rare disaster risks over not only financial markets, but also commodities with significant implications for policymakers and investors.