Counterfactual shock in energy commodities affects stock market dynamics: Evidence from the United States

Abstract

Abstract Volatilities in the stock market are due to fluctuations in essential energy commodities. This in effect underpins the impact of short- and long-run prices on producers, consumers, portfolio managers, and policymakers. To understand the past, present, and future dynamics of energy commodities and stock market uncertainty — this paper investigated the nexus between real stock index in the US. We investigated energy commodities namely oil price, coal price, and natural gas price employing over decadal monthly data from 1991:01 to 2019:12. The study applied autoregressive distributed lag (ARDL) and dynamic simulations of ARDL (DYNARDL) techniques to investigate long-term shocks in oil price, coal price, natural gas price, short-term interest rate, and industrial production index. The study found negative long-run relationship between real oil price, real coal price, real natural gas price, short-term interest rate, and real stock index, with only industrial production index reporting a positive relationship with real stock index in both ARDL and dynamic simulated ARDL models. While we found positive relationship between energy commodities and real stock index in the short run, negative relationship was reported between short-term interest rate, industrial production index, and real stock index. Incorporating real Western Texas Intermediate oil in S&P500 stock price index function corrects historical fluctuations by 64% compared to 54% speed of adjustment with real brent oil. The dynamic ARDL simulation further provides key insight into how energy commodity prices and economic activity shocks are transmitted to stock market prices in the U.S.