Oil shocks, US economic uncertainty, and emerging stock markets

ABSTRACT

This paper investigates the impacts of oil price shocks and US economic uncertainty on emerging equity markets within a structural VAR model. I find that both precautionary oil demand and US economic uncertainty shocks have significant negative effects on emerging stock returns, whereas aggregate demand shocks cause a sustained rise of the returns. In particular, the direct effects of oil shocks on emerging stock returns are amplified by the endogenous response of US economic uncertainty. Variance decomposition analysis shows that oil market fundamentals and US economic uncertainty are an important determinant of emerging equity returns, accounting for 35% and 24% of their long-term variations, respectively. The heterogeneous impacts of structural shocks on individual emerging markets, however, suggest that a well-diversified portfolio can be obtainable.

KEYWORDS:

• Oil shocks
• US economic uncertainty
• emerging stock markets
• structural VAR

JEL CLASSIFICATION:

• G15
• Q41
• Q43

Disclosure statement

No potential conflict of interest was reported by the author.

Notes

¹ According to the International Energy Agency (IEA), oil demand in emerging countries has overtaken that in industrialized countries since 2013.

² As described in Bekaert and Harvey (2017), emerging market GDP accounted for only 16% of the world GDP in 1987, but its share continues to rise and reaches to more than 40% in 2016. In addition, for equity market capitalization, the emerging market represented less than 1% of the world market in 1987, but it has increased more than a 10-fold in recent years.

³ Kang and Ratti (2013) and Kang and Ratti (2015) use the policy uncertainty index developed by Baker, Bloom, and Davis (2016) on the newspaper coverage frequency, whereas this paper uses the factor-based estimate of US economic uncertainty developed by Jurado, Ludvigson, and Serena (2015) using a rich set of macroeconomic time-series.

⁴ The selected period is effectively a collective post-liberalization period for most emerging countries as described in Bekaert and Harvey (2017).

⁵ A rise of the index indicates a higher demand for transport services driven by increased global economic activity. The data are available at Kilian’s webpage.

⁶ The one-month, three-month, and 12-month-ahead economic uncertainty indices are available at Ludvigson’s webpage. I use the one-month-ahead uncertainty as a benchmark and find that empirical results are robust to using different measures.

⁷ The insensitive response of Chinese stock market can be attributed to the fact that the financial market in China is under strong government regulation and thus largely closed to foreign investment.