The impact of oil price shocks on Tehran Stock Exchange returns: Application of the Markov switching vector autoregressive models

Global oil price fluctuations have a significant impact on various areas of the financial sector especially the stock market. This is evident in the oil-dominated Iranian economy. This study investigates the impact of world oil price shocks on the Tehran Stock Exchange using the Markov switching vector autoregressive (MS-VAR) model based on two regimes. Key variables for this study are world oil prices and the Tehran Stock Exchange Index. In addition, monthly time series data from 2002 to 2017 is used to estimate the MSIAH(2)-VAR(1) model and calculate the regime-dependent impulse response function of the impact of oil price shocks on the stock market under the different regimes. The findings show that the intercepts, coefficients, and variances of the model are different in both regimes and, based on the transition probability matrix, both the regimes are persistent. Thus, the shocks have both positive and negative impacts on the Tehran Stock Exchange in regimes one and two, respectively. This effect disappears earlier in regime two. Robustness tests employing daily data confirm the results of the monthly data. Nevertheless, regime-dependent analysis can provide a clearer understanding of Iran's economy to policymakers and investors.