Exploring the nexus between monetary uncertainty and volatility in global crude oil: A contemporary approach of regime-switching

Abstract

Understanding the complex relationship between global crude oil market volatility and monetary uncertainty motivates the study. Understanding crude oil's volatility is crucial because it affects the economy and geopolitics. Monetary uncertainty, caused by monetary policy decisions, exchange rate fluctuations, and global economic conditions, could affect crude oil markets. Thus, monetary uncertainty and crude oil volatility must be examined to understand the dynamics and inform policy. In this empirical work, we examine the effects of monetary uncertainty on global crude oil price volatility using a time-varying transition probabilities Markov regime-switching GARCH model (TVTP-MS-GARCH). Our approach differs from prior research by considering the potential nonlinearity and shifting patterns in the relationship between crude oil volatility and monetary uncertainty. Our in-sample analysis provides interesting evidence for regime changes between the two monetary variables. The results of our out-of-sample testing show that the asymmetric TVTP-MS-GARCH model outperforms the symmetric version in predicting crude oil volatility. This suggests that monetary uncertainty has an asymmetrical impact on crude oil price volatility. We perform several robustness tests to validate our findings, including alternate lag specifications of monetary uncertainty and varying estimation window sizes. These tests further reinforce the importance of considering the dynamic changes in monetary uncertainty when attempting to predict crude oil volatility. Overall, our research highlights the need for a more nuanced approach to understanding the relationship between crude oil prices and monetary uncertainty.