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Regime dependent effects and cyclical volatility spillover between crude oil price movements and stock returns

Christian Urom, Kevin O. Onwuka, Kalu Uma and Denis N. Yuni

International Economics, 2020, vol. 161, issue C, 10-29

Abstract: This paper has two aims. First, we measure the asymmetric effect of crude oil prices on stock returns under a regime switching framework in the context of major oil exporting countries namely: the United Arab Emirates (UAE), Qatar, Saudi Arabia, Russia, Venezuela and Kuwait. The key results from our baseline model suggest that stock returns in all the markets exhibit regime switching behaviour with the bull market regime dominating most of the period except for Russia. Also, we found strong linkages among the bear market periods with Qatar and Saudi Arabia exhibiting the strongest negative linkage. The UAE and Saudi Arabia are more likely to experience bearish market conditions at same period whereas Russia is segmented from other markets except Saudi Arabia. Results from our augmented model suggest that the effect of crude oil price varies across regimes, impacting more strongly on stock returns during recession than during periods of expansion especially in Venezuela and Saudi Arabia. Secondly, we examine volatility spillover from crude oil prices to stock returns and found a substantial cyclical volatility spillover from crude oil to returns especially in the UAE, Russia and Qatar and that the evolution of spillover follows key developments in the market for crude oil, geopolitical risks and then, global economic conditions. Our results hold profound implications for risk management and portfolio diversification strategy in oil exporting region.

Date: 2020
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DOI: 10.1016/j.inteco.2019.10.004

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Handle: RePEc:eee:inteco:v:161:y:2020:i:c:p:10-29