Tracing the sources of contagion in the oil-finance nexus

Scott Mark Romeo Mahadeo*, Reinhold Heinlein, Gabriella Legrenzi

*Corresponding author for this work

Research output: Chapter in Book/Report/Conference proceedingChapter (peer-reviewed)peer-review

Abstract

We introduce an approach to trace the genesis of contagion occurring in the oil-finance nexus, which consolidates veteran non-linear oil price measures derived from the empirical oil literature, to construct a rule-based specification for filtering structural oil market shocks into calm and extreme episodes. Such identified conditions are useful to understand how changing scenarios in the international crude oil market influence the dynamic relationships between the crude oil, exchange rate, and stock markets. As we are the first to explicitly consider how the relationship between the exchange rate and stock market change under extreme oil market shocks, our applications to a small emerging oil-exporter provide novel results about this particular linkage. We find that the positive supply shocks and negative demand shocks associated with the 2014/2015 oil price crash coincide with a marked increase in the inverse exchange rate-stock market relationship. This highlights the importance of including exchange rates when analysing the dependence between oil and stock markets. Our results also show that international financial crises, such as the Asian flu and dot-com crash, are episodes of contagion in an otherwise weak oil-stock market relationship. In addition, we provide findings which are consistent with previous empirical literature that extreme demand-side oil market shocks tend to dominate the absolute increase in cross-market linkages and that the 2008/2009 global financial crisis is the most prominent contemporary event in the oil-finance nexus in a pre-COVID-19 world.
Original languageEnglish
Title of host publicationApplications in Energy Finance
Subtitle of host publicationThe Energy Sector, Economic Activity, Financial Markets and the Environment
EditorsChristos Floros, Ioannis Chatziantoniou
PublisherSpringer
ISBN (Print)9783030929589
Publication statusAccepted for publication - 12 Jan 2022

Keywords

  • contagion
  • correlation
  • exchange rate
  • oil
  • shock
  • stock market

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