Volatility spillovers and dynamic conditional correlation between stock market returns and crude oil returns

Abstract

The present research studies the relationship between the crude oil market and the stock market at aggregate level. Aggregate stock market indices would not reflect the complete story as the industrial base of each country could be significantly different. Consequently, in addition to several aggregate stock market indices, this study considers level one industry stock market indices for both United States and United Kingdom in order to capture industry specific responses to oil price shocks. This study evaluated the nature of time-varying correlation between the stock market and the crude oil market using Dynamic Conditional Correlation Generalised Autoregressive Conditional Heteroscedasticity (DCC-GARCH) model. Results from DCC-GARCH(1,1) model show evidence of volatility clustering and persistence in stock market returns and crude oil returns. The results also show that there is no dynamic conditional correlation in ARCH effects between stock market returns and crude oil returns. The results further show that there is strong evidence of time-varying volatility correlation between stock market and crude oil returns volatility. Moreover this study employs a bivariate BEKK (named after Baba-Engle-Kraft-Kroner)GARCH(1,1) model in order to study volatility spillovers between crude oil returns and stock market returns. The results show that volatility spillovers are present in a bidirectional way as the shocks from oil market to stock market are significant and found to be common as the shocks going from stock market to the oil market.