Interactions between oil and financial markets - Do conditions of financial stress matter?

- Relationship between oil and financial variables is nonlinear. Shocks in the stressed regime usually have larger and longer effects than shocks in the normal regime.
- The inverse relationship between interest rate and oil price is conditioned on a number of factors, and is not robust throughout all circumstances.
- Relationship between oil price and US dollar is shock-dependent. A negative shock that depreciates the dollar triggers an oil price increase, yet a positive oil shock leads to an appreciation of the dollar.
- Oil's ability to hedge against rising risk is limited to a market with normal stress conditions.
- The US dollar serves as a safe haven when financial market is surrounded by great tension.

This study uses a structural threshold VAR model to study the nonlinear relationships between oil and financial variables. The threshold effect is robust across models having different structural orderings of shocks. Evidence shows that shocks associated with different financial stress regimes explain the asymmetric responses of the system. Shocks in the stressed regime usually have larger and longer effects than shocks in the normal regime. The inverse relationship between real interest rate and real oil price is conditioned on a number of factors, and is not robust across all manner of circumstances. The relationship between oil price and the US dollar is shock-dependent. A negative shock that depreciates the dollar may trigger an increase in oil price, yet a positive oil shock may lead to appreciation of the dollar. Finally, oil's ability to hedge against rising risk is limited to a market with normal stress conditions. It is the US dollar that generally serves as a safe haven when financial markets are enmeshed in considerable tension.