Permanent and transitory oil volatility and aggregate investment in Malaysia

This paper investigates the relation between aggregate investment and oil volatility and its permanent and transitory components for a developing country, Malaysia. In the paper, the components generalized autoregressive conditional heteroskedasticity (CGARCH) model is utilized to decompose conditional oil volatility into permanent oil volatility and transitory oil volatility. Respectively reflecting fundamental-driven and random shifts in oil volatility, they are expected to exert differential effects on aggregate investment. Adopting a vector autoregression (VAR) framework to allow feedback effects between aggregate investment and its determinants, the paper documents evidence supporting the adverse effects of conditional oil volatility, permanent oil volatility and transitory oil volatility on aggregate investment and real output. Interestingly, contrary to the findings for the developed markets (US and OECD), the real effects of permanent oil volatility tend to be stronger. These findings are reasonably robust to variable specification and measurements in the VAR system. Hence, there is an indication that heightened oil volatility accounts for the slumps in Malaysia's aggregate investment after the Asian financial crisis.