https://orcid.org/0000-0002-6499-0838
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ABSTRACT
This paper analyses the dynamic impact of geopolitical risks (GPRs) on real oil returns for the period February 1974 to August 2017, using a time-varying parameter structural vector autoregressive (TVP-SVAR) model. Besides the two variables of concern, the model also includes growth in world oil production, global economic activity (to capture oil-demand), and world stock returns. We show that GPRs (based on a tally of newspaper articles covering geopolitical tensions), in general, has a significant negative impact on oil returns, primarily due to the decline in oil demand captured by the global economic activity. Our results, thus, highlight the risk of associating all GPRs with oil supply shocks driven by geopolitical tensions in the Middle East, and hence, ending up suggesting that higher GPRs drive up oil prices.
Disclosure statement
No potential conflict of interest was reported by the authors.
Notes
1. While analysing rare disaster risks, Demirer et al. Citationforthcoming, as a part of robustness check, showed that GPRs can predict oil returns and volatility in a nonparametric causality-in-quantiles framework.
3. We would like to thank Professor Haroon Mumtaz for making the estimation codes available at: https://sites.google.com/site/hmumtaz77/research-papers.
5. The data can be freely downloaded from: https://www2.bc.edu/matteo-iacoviello/gpr.htm
6. As a robustness check, we also used another version of the GPRs index developed also by; Caldara and Iacoviello (Citation2018), which starts in 1985, based on leading 11 national and international newspapers (The Boston Globe, Chicago Tribune, The Daily Telegraph, Financial Times, The Globe and Mail, The Guardian, Los Angeles Times, The New York Times, The Times, The Wall Street Journal, and The Washington Post). Our results were qualitatively similar to those reported in the paper, but are available upon request from the authors.
7. This was also observed in our dataset. Complete details of the time-varying oil and stock real returns correlation, along with all other correlations obtained from the model, are available upon request from the authors.
8. Based on the search groups 1 to 6 discussed in the data segment, Caldara and Iacoviello (Citation2018) further disentangle the direct effect of adverse geopolitical events from the effect of pure geopolitical risks by constructing two indexes: The Geopolitical Threats (GPTs) index, which only includes words belonging to Search groups 1 to 4, and; the Geopolitical Acts (GPAs) index, based on only words belonging to Search groups 5 and 6. In in the Appendix of the paper, we present a comparison of the standardized dynamic correlation between oil-returns with GPAs, GPRs, and GPTs. As can be seen, while the pattern of the correlation is similar, GPR has a much stronger impact than GPT and GPA on oil returns towards the end of the sample. Also, during the early 2000s, starting with the 9/11 attacks, Iraq Invasion, middle-east tensions, a series of bombings like the ones in Madrid and London, and the Arab Spring, led the real oil returns to have a positive correlation with GPAs, which in turn also affected the correlation with overall GPRs. The short-lived positive relationship with GPTs is possibly due to the threats associated with the South Ossetian War Escalation. So these results are in line with the conventionally held view that higher geopolitical risk drives up oil prices.