Detection of Structural Regimes and Analyzing the Impact of Crude Oil Market on Canadian Stock Market: Markov Regime-Switching Approach

TL;DR

This paper uses a Markov regime-switching model to analyze how crude oil prices impact the Canadian stock market, revealing regime-dependent effects and volatility differences from 1970 to 2021.

Contribution

It introduces a Markov-switching VAR approach to distinguish regime-specific impacts of oil prices on stock returns, highlighting asymmetric effects and lag influences.

Findings

TSX exhibits two regimes: positive and negative returns.

Crude oil negatively affects stock returns in the positive regime.

Oil price lag decreases returns in the positive regime, increases in the negative.

Abstract

This study aims to analyze the impact of the crude oil market on the Toronto Stock Exchange Index (TSX)c based on monthly data from 1970 to 2021 using Markov-switching vector autoregressive (MSI-VAR) model. The results indicate that TSX return contains two regimes, including: positive return (regime 1), when growth rate of stock index is positive; and negative return (regime 2), when growth rate of stock index is negative. Moreover, regime 1 is more volatile than regime 2. The findings also show the crude oil market has negative effect on the stock market in regime 1, while it has positive effect on the stock market in regime 2. In addition, we can see this effect in regime 1 more significantly in comparison to regime 2. Furthermore, two period lag of oil price decreases stock return in regime 1, while it increases stock return in regime 2.