Re-examining oil price-stock market returns nexus in Nigeria using a two-stage Markov regime switching approach

Abstract

Purpose It has been said that oil price shocks affect stock market returns. However, empirical studies remain inconclusive regarding the nexus between oil price shocks and stock market returns. Consequently, the purpose of this study is to investigate the asymmetric impact of oil price shocks on stock returns in Nigeria. Design/methodology/approach A two-stage Markov regime-switching approach is used to examine the asymmetric effects of three different structural oil shocks on stock returns. The oil shocks, which include oil supply shock, aggregate demand shock and oil-specific demand shock, are derived using structural vector autoregressive. Monthly data that spans the period between January 1990 and December 2018 are deployed for estimation. Findings The linear estimation results show that only oil demand shock negatively and significantly affects the stock market returns. The Markov-switching regime results reveal that oil supply shock has a significant positive impact on the stock returns in a low-volatility state, whereas oil-specific demand shock negatively impacts the stock returns in a high-volatility state. Practical implications There is a need for policymakers and investors to take cognizance of not only the positive outcomes of a relatively stable state of oil price but also the negative consequences of a high-volatility state when formulating policy and making investment decisions, respectively. Originality/value This study differs from other similar studies in Nigeria that have examined the asymmetric relationship between oil price shocks and stock market return by using a two-stage Markov regime-switching approach. To the best of the authors’ knowledge, this is the first attempt at using this methodology.