Oil prices and financial stress: A volatility spillover analysis

Abstract

Volatility spillover between oil prices and financial stress index is examined. Analysis is conducted for sub-periods: pre-crisis, in-crisis, and post-crisis Oil prices spill on financial stress before the crisis, but spillover reversed after the crisis. Volatility transmission pattern has similar dynamics before and after the crisis. Implications for investors and policy makers are discussed. Keywords:Oil prices Financial stress index Causality Volatility spillover abstract This paper examines whether there is a volatility transmission between oil prices and financial stress by means of the volatility spillover test. We employ WTI crude oil prices and Cleveland financial stress index for the period 1991-2014 and divide the sample into pre-crisis, in-crisis, and post-crisis periods due to the downward trend in oil price in 2008. The volatility model estimations indicate that oil prices and financial stress index are dominated by longrun volatility. The volatility spillover causality test supports evidence on risk transfer from oil prices to financial stress before the crisis and from financial stress to oil prices after the crisis. The impulse response analysis shows that the volatility transmission pattern has similar dynamics before and after the crisis and is characterized by higher and long-lived effects during the crisis. Our results have implications for both policy makers and investors, and for future work.

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“…Recent works in this line document a bidirectional relationship between oil prices and financial volatility (e.g. Basher and Sadorsky, 2016;Das et al, 2018;Nazlioglu et al (2015).…”

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“…Finally, future research might try to integrate other relevant factors into our model to get further insight about what oil price uncertainty actually represents and to control for additional sources of uncertainty. Some promising ground for this has already been laid out by Nazlioglu et al (2015), and Antonakakis et al (2014), for instance, who find significant relationships between oil price uncertainty and financial uncertainty, and oil price shocks and policy uncertainty, respectively. …”

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