Responses of international stock markets to oil price surges: a regimeswitching perspective

We propose an enhanced regime-switching model to investigate the relationships between oil price surges and stock market cycles in five oil-dependent countries over the period from January 1989 to December 2007. Our model accounts for the joint effects of the WTI (West Texas Intermediate) and Brent oil markets and allows to simultaneously capture asymmetry, volatility persistence and regime shifts contained in the underlying financial data. We find that stock market returns strongly exhibit a regime-switching behavior, but they react differently to the increases in the price of oil. More precisely, the conditional volatility of studied stock markets during the bear market phases is found to be less affected by oil price shocks than during the bull market phases. Whether the effects of oil shocks are positive and negative depends greatly on the degree of reliance on imported oil, the share of the cost of oil in the national income and the degree of improvement in energy efficiency of a given country. Finally, the relatively opposite effects of the WTI and Brent oil markets suggest the potential of substitution between them as well as the necessity of a diversification strategy of oil supply sources.