Is the impact of oil shocks more pronounced during extreme market conditions?

Abstract

The international oil market has the tendency to affect any economy either developed or emerging. We examine the effect of structural oil shocks on the returns of developed and emerging stock markets. This effect is measured by employing the extreme dependence measure and connectedness approach across different quantile distributions. Our data ranges from January 1, 2006, to July 5, 2021. Oil shocks are extracted using the work of Ready (2018) as supply, demand and risk-related shocks. Our results highlight that demand shocks exhibit strong coherence as compared with supply and risk-driven shocks in the short-run. However, during extreme market conditions, we witness the pronounced effect of oil shocks on stock returns. Results of connectedness using Ando et al. (2022) show that France significantly transmits to the system across all quantile distributions. Among BRICs, Brazil appears as the most substantial net contributor. In terms of net receiver, Japanese equity market appears most sensitive to oil shocks followed by the Indian and Chinese stock markets. Our work carries important implications for investments and policymakers.