The Impact Of Oil Price Shocks On The US Stock Market: A Note On The Roles Of US And Non-US Oil Production

Wensheng Kang
Kent State University – Department of Economics

Ronald A. Ratti
University of Western Sydney – Department of Economics & Finance

Joaquin L. Vespignani
University of Tasmania – School of Economics and Finance

June 9, 2016

CAMA Working Paper No. 32/2016

Abstract:

Kilian and Park (IER 50 (2009), 1267-287) 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 U.S. 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 analyzing impact on U.S. stock prices. A positive U.S. oil supply shock has a positive impact on U.S. real stock returns. Oil demand and supply shocks are of comparable importance in explaining U.S. real stock returns when supply shocks from U.S. and non-U.S. oil production are identified.

The Impact Of Oil Price Shocks On The US Stock Market: A Note On The Roles Of US And Non-US Oil Production – Introduction

Kilian and Park (2009) present a novel method for examining the relationship between U.S. stock market behavior 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 much less important than global aggregate and oilspecific demand shocks in understanding aggregate U.S. stock market behavior. Our study is concerned with the question: Do U.S. oil supply shocks affect U.S. real stock market returns?

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. 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. In addition, enhanced U.S. oil production has consequences for political and economic security and hence U.S. asset markets that are likely to be different from increases in non-U.S. oil production. The recovery of U.S. oil production in recent years is illustrated in Figure 1. We investigate the effect of disaggregating the world oil production variable in Kilian and Park’s (2009) VAR model into U.S. oil production and non-U.S. oil production. Hendry and Hubrich (2011) argue that including disaggregated information improves forecast accuracy in VAR models.

Oil Price Shocks

In this study we revisit Kilian and Park’s (2009) analysis to examine the effect of world oil supply shocks on the U.S. real stock market returns. 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. A positive U.S. oil supply shock has a statistically significantly positive impact on U.S. real stock returns in the fourteenth month and later. This result is sensitive to the inclusion of recent data that captures shale oil production. In a sample ending before the start of shale oil production, a positive U.S. oil supply shock has a statistically significantly positive impact on U.S. real stock returns only in the twenty-first and twenty-second months.

Variance decomposition analysis shows 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 the Kilian and Park (2009) result) in explaining U.S. real stock returns.

Oil Price Shocks

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