Abstract:
This paper examines the relationship between US crude oil and stock market prices, using a Markov-Switching
vector error-correction model and a monthly data set from 1859 to 2013. The sample covers the entire modern
era of the petroleum industry, which typically begins with the first drilled oil well in Titusville, Pennsylvania in
1858. We estimate a two-regime model that divides the sample into high- and low-volatility regimes based on
the variance–covariance matrix of the oil and stock prices. We find that the high-volatility regime
more frequently exists prior to the Great Depression and after the 1973 oil price shock caused by the
Organization of Petroleum Exporting Countries. The low-volatility regime occurs more frequently when
the oil markets fell largely under the control of the major international oil companies from the end of
the Great Depression to the first oil price shock in 1973. Using the National Bureau of Economic research
business cycle dates, we also find that the high-volatility regime more likely occurs when the economy
experiences a recession.
