Essays on the Effects of Oil Price Shocks on Financial Markets and Industries

The aim of this dissertation is to extend the literature on the connection between oil and the economy, by investigating the impacts of oil price shocks on financial markets and industries. The first chapter of my thesis is devoted to give a new look to the relation between the stock market return and the oil price shocks in the US stock markets. This study empirically models oil price changes as driven by speculative demand shocks along with consumption demand and supply shocks in the oil market. It also takes into account all the factors that affect stock market price movements over and above the oil market, in order to quantify the pure effects of oil price shocks on returns. The results show that stock returns respond to oil price shocks differently, depending on the causes behind the shocks. Consumption demand shocks are the most relevant drivers of the stock market return, relative to other oil market shocks. Industry level analysis is performed to control for the heterogeneity of the responses of returns to oil price changes. The results show that both cost side and demand side effects of oil price shocks matter for the responses of industries to oil price shocks. The second chapter investigates the effects of oil price shocks, including oil specific and macroeconomics shocks to the oil market, on volatility of selected agricultural and metal commodities. The investigation is divided into two subsamples, before and after 2006 for agricultures taking into account the 2006-2008 food crisis, and before and after 2008 for metals considering the global financial crisis. The results show that the response of volatility of each commodity to an oil price shock differs significantly depending on the underlying cause of the shock for the both pre and post-crisis periods. moreover, the explanatory power of oil shocks becomes stronger after the crisis. The different responses of commodities are described in detail by investigating market characteristics in each period. The third chapter studies the relationship between investment and uncertainty in a panel of U.S. firms in oil and gas industry. The paper decomposes oil price uncertainty to be driven by the shocks to supply of oil, global consumption demand for oil and all industrial commodities and other oil market-specific demands, to investigate whether and how investment-uncertainty relationship depends on the causes behind uncertainty. %By estimating an augmented Q model of investment, The findings show that %the investment-uncertainty relation depends greatly on the causes behind uncertainty. oil market uncertainty lowers investment only when it is driven by global demand shocks. When it is driven by oil supply shocks and oil market-specific demand shocks, it has no significant effect on investment. Stock market uncertainty found to negatively affect investment. The results show no positive relation between investment and uncertainty but the negative relation is not always correct. This is in line with the option theory of investment and shows that the irreversibility effect of increased uncertainty dominates the traditional convexity effect.