The Effect of Oil Supply Shocks on U.S. Economic Activity: What Have We Learned?

Herrera, Ana María; Rangaraju, Sandeep Kumar

doi:10.2139/ssrn.3170422

Cited by 19 publications

(37 citation statements)

References 37 publications

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“…Employing various proxies for uncertainty, several authors report a negative and significant relationship between investment and 1 This structural model of the global oil market has been widely used in the literature, for example, Baumeister and Kilian (2015), Baumeister and Kilian (2016), Kilian and Lee (2014), Kilian (2017) and Herrera and Rangaraju (2018 Abel (2018), in a study of the relationship between investment, Q and cash flow, shows that cash flow has explanatory power for investment and this effect is even larger for faster growing firms that are likely to be financially constrained. 6 See, e.g., Cukierman (1980), Bernanke (1983), McDonald and Sigel (1986), Pindyck (1991), Dixit and Pindyck (1994), and Chirinko (1993).…”

Section: Literature Reviewmentioning

confidence: 99%

The investment-uncertainty relationship in the oil and gas industry

2019

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JEL classification: C3 G11 Q41 Q43 A B S T R A C TRecent studies of the oil market demonstrate endogeneity of the oil price by modelling it as a function of consumption and precautionary demands and producers' supply. However, studies analysing the effect of oil price uncertainty on investment do not disentangle uncertainties raised by underlying components which play a role in the oil market. Accordingly, this study uses a new approach to investigate the relationship between investment and uncertainty for a panel of U.S. firms operating in the oil and gas industry. We decompose oil price volatility to be driven by structural shocks that are recognized in the oil market literature, over and above other determinants, in order to study whether the investment uncertainty relationship depends on the drivers of uncertainty. Our findings suggest that oil market uncertainty lowers investment only when it is caused by global (consumption) oil demand shock. Stock market uncertainty is found to have a negative effect on investment with a year of delay. The results suggest no positive relationship between irreversible investment and uncertainty, but interestingly, a positive relation exists for reversible investment. This finding is in line with the option theory of investment and implies that the irreversibility effect of increased uncertainty dominates the traditional convexity effect.

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Section: Literature Reviewmentioning

confidence: 99%

The investment-uncertainty relationship in the oil and gas industry

2019

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“…An alternative approach in the literature has been to rely on Bayesian methods that allow us to specify explicit priors on the one-month price elasticities of oil demand and oil supply (see Table 5). Herrera and Rangaraju (2020) show that bounding the oil supply elasticity by 0.1 reduces the posterior median estimate of the supply elasticity in Baumeister and Hamilton's model from 0.15 to 0.08 13 As shown in Inoue and Kilian (2020), this approach implies highly unrealistic priors on the impulse response functions. For a more detailed review of the econometric approach of Baumeister and Hamilton (2019) and its drawbacks see Kilian and Zhou (2020c) and Kilian (2020).…”

Section: Baumeister and Hamilton (2019)mentioning

confidence: 92%

Understanding the Estimation of Oil Demand and Oil Supply Elasticities

Kilian¹

2020

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This paper examines the advantages and drawbacks of alternative methods of estimating oil supply and oil demand elasticities and of incorporating this information into structural VAR models. I not only summarize the state of the literature, but also draw attention to a number of econometric problems that have been overlooked in this literature. Once these problems are recognized, seemingly conflicting conclusions in the recent literature can be resolved. My analysis reaffirms the conclusion that the one-month oil supply elasticity is close to zero, which implies that oil demand shocks are the dominant driver of the real price of oil. The focus of this paper is not only on correcting some misunderstandings in the recent literature, but on the substantive and methodological insights generated by this exchange, which are of broader interest to applied researchers.

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“…Based on the more comprehensive micro data set of U.S. producers of shale oil and conventional oil in Newell and Prest (2017), the implied aggregate price elasticity of oil supply is well below 0.01. 15 Further discussion of the derivation of this bound and the sensitivity of the VAR estimates to relaxing this bound can be found in Kilian and Murphy (2012), Herrera and Rangaraju (2018), Zhou (2018), and Kilian and Zhou (2018b).…”

Section: Narrative Sign Restrictionsmentioning

confidence: 99%