Oil shocks and stock market volatility: New evidence

This paper investigates the effect of oil shocks on U.S. stock market volatility based on a new hybrid model that combines the least absolute shrinkage and selection operator (LASSO) with the Markov regime-switching model (MS-LASSO). Considering five oil shocks, the results show that the LASSO method containing Markov regime-switching improves forecasting accuracy from the statistical and economic perspectives. These results are confirmed in robustness checks of alternative evaluation method, alternative forecasting horizons, and alternative historical years. Moreover, we find that the net price increase indicator (NPI2) is an effective oil shock, while the large price increase (LPI) has nearly no influence during the sample period. Furthermore, we find that oil shocks have time-varying performance, which highlights the importance of considering regime switching.

Automated summary

This study examines the impact of oil shocks on U.S. stock market volatility using a hybrid model of LASSO and MS-LASSO, finding that NPI2 is an effective oil shock indicator while LPI has little influence. The results also highlight the importance of considering regime switching for oil shocks that exhibit time-varying performance.