Essays on the relationship between oil and financial markets

Abstract

This thesis contains of three empirical essays on the area of energy economics. In particular, we investigate the impact of oil price changes on the financial market performance and generally the relationship between oil markets and financial markets. During the last two decades, the examination of this relationship has received particular attention by the research community, however, research in this area is still growing. Indeed, oil price peaks and troughs create uncertainty to the financial markets and therefore a link between the two markets is continuously set and requires further attention.
A plausible explanation regarding the growing popularity of research in this area can be attributed to the fact that oil price fluctuations have been noteworthy increased since the recent global financial crisis of 2007-2009. In addition, financial markets seem to be significantly affected by developments created during this period, since financial institutions collapsed. Furthermore, the financialisation (increasing speculative trading) of the oil market which coincides with this period suggests that oil futures derivatives are considered as financial assets by market participants. Therefore, this research choice based on the fact that these two markets appear to be highly linked the recent years. Overall, the latest developments suggest that the relationship between oil markets and financial markets may potentially change. Subsequently, the aim of this study is to enhance the existing literature by investigating changes in the patterns between the two markets.
To this end, we employ monthly data available from commercial data suppliers such as Thomson-Reuters or Bloomberg. Regarding the time period, both the beginning period and the end period of our sample depend on the needs of each empirical chapter and the data availability. In terms of econometric methods, the chosen frameworks vary in order to accommodate each empirical study specific requirements. In this regard, we employ a battery of single-equation multiple linear regression models, a Scalar-Baba-Engle-Kraft-Kroner (BEKK) model and a structural vector autoregressive model (SVAR). All three static and time-varying specifications have been well explained by the existing literature, are well-matched with the economic theory and have been adopted by many authors in their research.
The first empirical chapter examines the determinants of WTI/Brent oil futures price differential and the globalisation-regionalisation hypothesis in the oil futures market. The findings suggest that the WTI/Brent oil futures price differential is influenced by crude oil-market specific (convenience yield, consumption, production) and oil-futures market specific (open interest, trading volume) determinants. In addition, the oil futures market appears to be regionalised in the short-run.
The second empirical chapter examines the time-varying correlation between oil price shocks and the 10-year sovereign yield spread of core and periphery countries in the EMU. The results reveal that the correlation between sovereign yield spreads and oil price shocks is indeed time-varying and show heterogeneity among the three oil price shocks (supply-side, aggregate demand, precautionary demand). Specifically, the correlation varies between positive and negative areas. Furthermore, even though the correlation patterns are constantly low or zero prior to the Great Recession, a change is revealed in the post-2008 period, when correlations become moderate and more volatile.
The third empirical chapter investigates the origins of precautionary demand in the oil market and its effects on stock market returns and volatility in the US. The precautionary demand is disaggregating into two components, the precautionary demand shock based on the convenience yield and the idiosyncratic oil price shock. The results demonstrate that oil price changes are affected in a smaller magnitude by precautionary demand shocks, whereas the largest effect is generated by idiosyncratic oil price shocks. Furthermore, stock market returns and stock market volatility are affected differently by these two shocks before and after the Great Recession of 2007-2009.
Overall, the findings of this study contribute to the existing oil-related literature by filling voids and provide avenues for further research in the attention of researchers. In addition, our results may be of interest to energy investors and financial traders since oil market is appeared to be financialised the recent years and the oil futures market-related products are considered as financial assets.

Date of Award	Oct 2019
Original language	English
Awarding Institution	University of Portsmouth
Supervisor	Renatas Kizys (Supervisor) & George Filis (Supervisor)