Oil shocks and stock market: Revisiting the dynamics

Abstract

The impact of crude oil shocks on the real and financial sector depends on its origin. This study examines the expected demand and supply specific oil shocks on stock market returns and its volatility in the Indian context. Time-Varying Parameter Structural Vector Autoregression-Stochastic Variance (TVP-SVAR-SV) model is used to estimate the models and identify the oil supply shocks, demand specific oil shocks and macro uncertainty shocks. The model is estimated using monthly crude oil price changes, returns of the major oil-producing companies, Policy Uncertainty Index and the stock returns from Jan 2003 to Feb 2020. The impact of oil shocks on stock return volatility is also analysed replacing stock returns with its realised volatility. The impulse response of the Indian stock returns and its volatility from TVP-SVAR-SV model indicate that expected oil demand shocks significantly affect the stock returns and its volatility. However, the results suggest no impact in the case of supply shocks. Similarly, shocks to policy uncertainty leads to negative returns and an increase in its volatility. • Expected demand and supply specific oil shocks on stock market returns and its volatility in the Indian context is examined. • Results indicate that expected oil demand shocks significantly affect the stock returns and its volatility. • No impact on Indian stock returns and its volatility due to oil supply shocks. • Shocks to policy uncertainty negatively impact stock returns and exacerbate return volatility.