Abstract
This paper applies Markov-switching method to identify bear and bull market regimes and adopts interactive double-dummy variable approach to re-investigate the conditional relationship between the real oil price return and the international real stock return in 15 OECD countries when the sample is split into bear markets and bull markets. The empirical results indicate that, once the stock index is in the bull trend, an increase in oil price cannot affect the real stock return, while a decrease in oil price can lead to higher stock returns. On the contrary, if the stock market is in the bear era, the oil price growth cannot significantly affect the stock returns. Remarkably, oil price shocks cannot always damage the broad stock index, especially in a bull market era. Furthermore, regardless of the oil price shock, long-term investors need not adopt any policy and strategy to reduce the impact of the oil price on the stock market because the effect of a bull stock market will weaken the negative effect of an oil price shock. On the other hand, regardless of oil price shocks, when the stock market exhibits a bear trend, investors should adopt coping policies and strategies to avoid the impact of other non-oil factors shock, such as declines in real GDP to the stock market in the 15 selected countries. Clearly, regardless of whether the stock market exhibits a bear trend or a bull trend, the stock market trend will surpass the effect of an oil price shock.
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Notes
“...The bull market displays high returns coupled with low volatility, but the bear market has a low return and high volatility...” (see Maheu and McCurdy 2000, pp. 101). “\({\ldots }\)periods of rising stock prices, the so-called bull markets, and periods of declining stock prices, i.e., “bear” periods\({\ldots }\) a bull or a bear market is a period of consecutive monthly increases or decreases in stock prices the horizon of which is perceived to last well beyond one month. Indeed, in our present analysis, we examine horizons of three months and longer\({\ldots }\)” (see Hardouvelis and Theodossiou 2002, pp. 1539).
Apart from studying the linear relationship, the asymmetric relationship between oil prices and macroeconomic variables has gradually become a concern. For example, Mork (1989) first adopted the specifications of positive oil price and negative oil price and found an asymmetric relationship between the oil price and US economic activities. Beyond that, Mork et al. (1994) also found that an asymmetric relationship exists between the oil price and economic activities in some OECD countries.
According to Ritter and Warr (2002) and Meric et al. (2008), since 1970, the bull market has covered the period from 1982 to 2000. In addition, according to an article in the Economist entitled “The Big Bear,” the twentieth century can be divided into six phases: bear markets for 1901–1921, 1929–1949 and 1965–1982, and bull runs for 1921–1929, 1949–1965 and 1982–2000 (October 16, 2008).
Fig. 1 
US stock index and real oil price trend
Pagan and Sossounov (2003) selected this slightly longer and probably established on 8 months as the suitable length for the cycle of stock prices. For example, they identify the \(\hbox {Peaks}=\left[ \ln p_{t-8} \ldots \ln p_{t-1} < \ln p_t > \ln p_{t+1}, \ldots \ln p_{t+8} \right] ,\, \hbox {Toughs}=\left[ {\ln p_{t-8} \ldots \ln p_{t-1} > \ln p_t < \ln p_{t+1} ,\ldots \ln p_{t+8} } \right] \).
Dummy variables have been widely used to explain nonlinear relationships or asymmetrical relationships in various fields. According to Hardy (see Hardy 1993, pp. 5), dummy variables are useful in both cross-sectional and time-series studies.
Based on the method proposed by Hamilton (1989), we found that the market is more likely to be in a bull (bear) market when regime probabilities \(Pr (S_t =2)\) are greater (less) than 0.5.
Because the instrumental variables relation with equation is difficult to obtain, this paper attempted to use sunspot as the instrumental variable based on Modis’s (2007) findings that the sunspot can be used to forecast US GDP and Dow Jones Index. Our results showed that the OLS model is superior to 2SLS for majority of the countries studied.
Durbin–Wu–Hausman test and J statistic.
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Liao, SY., Chen, ST. & Huang, ML. Will the oil price change damage the stock market in a bull market? A re-examination of their conditional relationships. Empir Econ 50, 1135–1169 (2016). https://doi.org/10.1007/s00181-015-0972-5
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DOI: https://doi.org/10.1007/s00181-015-0972-5