The effect of oil price on industrial production and on stock returns

Abstract

This paper analyzes the relationship between oil price shocks and the industrial production and between oil price shocks and the stock returns. The objective is to study which relationship is stronger or which variables reacts more rapidly to changes in oil price. We develop a Markov switching model assuming that there exits a latent variable (the state of the economy) which determines the mean of industrial production and the volatility of stock returns. The reults show that raises in oil price affects in a negative and statistically significant way to stock returns and to industrial production, but the effect on stock returns is stronger than on industrial production.