Time-Varying Transmission Mechanism of Oil Shocks in the Global Crude oil Market: A TVP-VAR Approach

In this paper, we have utilized a time-varying parameter vector autoregressive model in order to examine the structural changes in the transmission mechanisms of oil price shocks in the global crude oil market over the period of 1985-2016. In this setting, the contemporaneous response of real oil price and crude oil production to flow oil supply shock, flow oil demand shock, and speculative demand shocks are explored. Results obtained from using Monte Carlo Markov Chain estimation method along with the identification approach proposed by Killian and Murphy (2014) reveal that the impact responses of oil production to the structural shocks follows a decreasing trend throughout the past three decades mainly due to the erosion of global oil production spare capacity. The reaction of oil production to flow oil supply shock is also estimated to be greater than other demand shocks over all dates. Moreover, the contemporaneous impact of structural shocks on real oil prices fail to show a clear pattern, however, jumps experienced in periods where uncertainty heightened and risk aversion strengthened is distinct. The reaction of real crude oil price to flow oil supply shock was more pronounced in 1990s and the period subsequent to oil price plunge in 2014. By contrast, the role of flow oil demand shock in real crude oil price fluctuations was dominant over the period of 2000-2014. While the oil production reacted more strongly to speculative demand shock rather than flow oil demand shocks, the response of real oil price to these two oil demand shocks is completely reversed.