The Impact Of Oil Price Shocks On The U.S. Stock Market: A Note On The Roles Of U.S. And Non-U.S. Oil Production
Kent State University – Department of Economics
University of Western Sydney – Department of Economics & Finance
Joaquin L. Vespignani
University of Tasmania – School of Economics and Finance
2015-09-01
Globalization and Monetary Policy Institute Working Paper No. 249
Abstract:
Kilian and Park (IER 50 (2009), 1267-1287) find shocks to oil supply are relatively unimportant to understanding changes in U.S. stock returns. We examine the impact of both U.S. and non-U.S. oil supply shocks on stock returns in light of the unprecedented expansion in U.S. oil production since 2009. Our results underscore the importance of the disaggregation of world oil supply and of the recent extraordinary surge in the U.S. oil production for analysing impact on U.S. stock prices. We also show that stock returns respond very differently at the industrial level to non-U.S. and U.S. oil supply shocks.
The Impact Of Oil Price Shocks On The U.S. Stock Market: A Note On The Roles Of U.S. And Non-U.S. Oil Production
Kilian and Park (2009) present a novel method for examining the relationship between stock market behaviour and oil price shocks. Building on the seminal contribution in Kilian (2009), which demonstrates that demand and supply shocks in the market for oil have different effects on the U.S. economy and the real oil price, they show that the reaction of U.S. real stock returns to an oil price shock depends on the source of the underlying cause of the oil price change. One of the major conclusions in Kilian and Park (2009) is that global oil supply shocks are less important than global aggregate and oil-specific demand shocks in understanding aggregate U.S. stock market behaviour. This inference is accentuated by sector-specific U.S. stock returns varying significantly in response to demand side shocks in the crude oil market and not reacting significantly to shocks to world oil production.
After several decades of steady decline in the U.S. oil production, innovations and new technologies in the extraction of crude oil have resulted in an unprecedented expansion in U.S. oil production in recent years.1 This development is significant because an increase in U.S. crude oil production directly boosts U.S. domestic income compared with an increase in non-U.S. crude oil production. The recovery of U.S. oil production in recent years is illustrated in Figure 1. Figure 1 shows the behaviour of monthly U.S. crude oil production, and for comparison, non-U.S. crude oil production. The contribution of shale oil output to U.S. oil production is indicated by the shaded area in Figure 1. After U.S. oil output trended upwards to a maximum in November 1970 of 10.044 million barrels per day (not shown), production gradually fell to 8.854 million barrels per day in January 1977, before rising to a local maximum in January 1986 of 9.137 million barrels per day. After January and February 1986 U.S. oil production successively fell to below 6 million barrels per day in January 1999 and remained below this level until November 2011. U.S. oil output in January 2015 amounted to 9.305 million barrels per day, up from production of 5.497 million barrels per day in January 2011, representing an increase of over 69%.
Where Kilian and Park (2009) consider the role of world oil supply, we examine the impact of both U.S. and non-U.S. crude oil supply shocks on U.S. real stock returns in light of the exceptional increase in U.S. oil production. While the influence of real oil price on U.S. stock returns is informed by whether global aggregate and oil-specific demand shocks are the driving force of oil price change, U.S. real stock returns might well be influenced by the source of innovation in crude oil production. In this study we revisit Kilian and Park’s (2009) major paper to examine the effect of world oil supply shocks on U.S. real stock market returns. Our study is concerned with the questions: Do U.S. oil supply shocks affect U.S. real stock market returns? How do U.S. oil supply shocks affect real stock market returns of major industries?
To assess whether U.S. real stock returns are influenced by the source of innovation in crude oil supply shocks, we build on Kilian and Park’s (2009) Vector Autoregressive model (VAR) by disaggregating world crude oil supply shocks in that model into U.S. and non-U.S. oil supply shocks. We find that both the disaggregation of world oil supply and the unprecedented surge in the U.S. oil production since 2009 are important factors in determining U.S. real stock returns. Variance decomposition analysis show that by disaggregating world oil production into U.S. and non-U.S. oil production, supply shocks are comparable to demand shocks (in contrast to Kilian and Park’ (2009) results) in explaining U.S. real stock returns. In particular, for the period 1973:02-2006:12 (the original sample in Kilian and Park (2009)) supply shocks explain 14.1% of the U.S. real stock returns, while demand shock explain 16.8%. For the period 1973:02-2014:12, supply and demand shocks account for 11.9% and 11.6%, respectively, of the variation in U.S. real stock returns.
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