Dynamic impact of crude oil price shocks on equity market returns; A simple MS-EGARCH approach

Abstract

This study is motivated by the empirical association between crude oil price shocks and stock market returns as well the asymmetric and nonlinear effects of crude oil price movement with stock returns. Thus, the EGARCH model is employed to investigate the dynamic impact of crude oil price on equity returns in terms of it asymmetric and nonlinear effects.

We find a significant switching behaviour for our sample with varying impacts across the selected regimes. The result from our simple Markov-switch model is found to be more robust and significant compared to the extended model estimated with additional exogenous variable. Specifically, for our simple model the regime specific error variances are positive and significant for both the low and high volatility regimes in all the equity market studied. We also obtain a significant transition matrix parameter for all the equity markets in our sample with significant dynamic transition probabilities in both the low and high volatility regimes.