The impact of oil price shocks on Turkish sovereign yield curve

Abstract

PurposeThis paper aims to investigate the impact of oil price shocks on the Turkish sovereign yield curve factors.Design/methodology/approachTo extract the latent factors (level, slope and curvature) of the Turkish sovereign yield curve, we estimate conventional Nelson and Siegel (1987) model with nonlinear least squares. Then, we decompose oil price shocks into supply, demand and risk shocks using structural VAR (structural VAR) models. After this separation, we apply Engle (2002) dynamic conditional correlation GARCH (DCC-GARCH (1,1)) method to investigate time-varying co-movements between yield curve factors and oil price shocks. Finally, using the LP (local projections) proposed by Jorda (2005), we estimate the impulse-response functions to examine the impact of different oil price shocks on yield curve factors.FindingsOur results demonstrate that the various oil price shocks influence the yield curve factors quite differently. A supply shock leads to a statistically significant increase in the level factor. This result shows that elevated oil prices due to supply disruptions are interpreted as a signal of a surge in inflation expectations since the cost channel prevails. Besides, unanticipated demand shocks have a positive impact on the slope factor as a result of the central bank policy response for offsetting the elevated inflation expectations. Finally, a risk shock is associated with a decrease in the curvature factor indicating that risk shocks influence the medium-term bonds due to the deflationary pressure resulting from depressed economic conditions.Practical implicationsOur results provide new insights to understand the driving forces of yield curve movements induced by various oil shocks to formulate appropriate policy responses.Originality/valueThe study contributes to the literature by two main dimensions. First, the recent oil shock identification scheme of Ready (2018) is modified using the “geopolitical oil price risk index” to capture the changes in the risk perceptions of oil markets driven by geopolitical tensions such as terrorism and conflicts and sanctions. The modified identification scheme attributes more power to demand shocks in explaining the variation of the oil price compared to that of the baseline scheme. Second, it provides recent evidence that distinguishes the impact of oil demand and supply shocks on Turkey's yield curve.

Global commodity prices and inflation expectations

“…However, the volatility of commodity prices is likely to affect the household inflation expectations. As discussed earlier, we find that some studies estimate the effect of the volatility of oil prices on other economic variables (Cepni et al , 2020). There exists little evidence regarding the importance of volatility of global commodity prices on household inflation expectations.…”

“…High volatility in the value of a variable creates uncertainty and confusion among firms and consumers about its future path and can affect other related variables (Kumar, 2013). For example, volatility in oil prices affects yield curve (Cepni et al , 2020), exchange rate volatility makes predicting exchange rate difficult (Emenike, 2018) and inflation volatility affects the inflation-output trade-off (Jha and Kulkarni, 2015) and political frustrations or volatility leads to decline in investments [1] (Alon and McKee, 2006).…”

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“…Our findings are consistent with those of [ 52 , 53 ], who found that changes in oil market shocks explain BRICs stock returns oil. Market conditional value-at-risk can be used to represent this phenomenon [ 54 ]. study also supports a higher hedging ratio during the global crisis, confirming the oil-stock market's historical performance fluctuations [ 55 ].…”

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“…The hypothesis is supported by the standardized path coefficient of 0.16 between social capital and inventive behavior, which is smaller than 0.05. In conclusion [ 65 ], discovered that information sharing has a favorable impact on creative behavior and that social capital benefits knowledge sharing and innovation. The research supports that social capital and information sharing are crucial in encouraging innovation in public organizations.…”