Hostname: page-component-5cf477f64f-bmd9x Total loading time: 0 Render date: 2025-04-01T10:38:34.243Z Has data issue: false hasContentIssue false
  • English
  • Français

VOLATILITY IN OIL PRICES AND MANUFACTURING ACTIVITY: AN INVESTIGATION OF REAL OPTIONS

Published online by Cambridge University Press:  14 December 2011

John Elder  and
Apostolos Serletis
John Elder*
Affiliation:
Colorado State University
Apostolos Serletis
Affiliation:
University of Calgary
*
Address correspondence to: John Elder, Department of Finance and Real Estate, Colorado State University, 1272 Campus Delivery, Fort Collins, CO 80523-1272, USA; e-mail: john.elder@colostate.edu.
Get access Rights & Permissions [Opens in a new window]

Abstract

Previous research shows that volatility in oil prices has tended to depress output, as measured by nonresidential investment and GDP. This is interpreted as evidence in support of the theory of real options in capital budgeting decisions, which predicts that uncertainty about, for example, commodity prices will cause firms to delay production and investment. We continue that investigation by analyzing the effect of oil price uncertainty on monthly measures of U.S. firm production related to industries in mining, manufacturing, and utilities. We use a more general specification, an updated sample that includes the increased oil price volatility since 2008, and we control for other nonlinear measures of oil prices. We find additional empirical evidence in support of the predictions of real options theory, and our results indicate that the extreme volatility in oil prices observed in 2008 and 2009 contributed to the severity of the decline in manufacturing activity.

Keywords

Oil VolatilityUncertaintyMultivariate GARCH VARReal Options
Type
Articles
Information
Macroeconomic Dynamics , Volume 15 , Supplement S3: Oil Price Shocks , November 2011 , pp. 379 - 395
Copyright
Copyright © Cambridge University Press 2011

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

REFERENCES

Bernanke, Ben S. (1983) Irreversibility, uncertainty, and cyclical investment. Quarterly Journal of Economics 98, 85–106.CrossRefGoogle Scholar
Bernanke, Ben S., Gertler, Mark, and Watson, Mark (1997) Systematic monetary policy and the effects of oil price shocks. Brookings Papers on Economic Activity 1, 91–142.CrossRefGoogle Scholar
Bredin, Don, Elder, John, and Fountas, Stilianos (2010) The Effects of Uncertainty about Oil Prices in G-7. Working paper, Colorado State University.Google Scholar
Brennan, Michael (1990) Latent assets. Journal of Finance 45, 709–730.CrossRefGoogle Scholar
Brennan, Michael and Schwartz, Eduardo (1985) Evaluating natural resource investment. Journal of Business 58, 1135–1157.Google Scholar
Dixit, Avinash and Pindyck, Robert S. (1994) Investment under Uncertainty. Princeton, NJ: Princeton University Press.CrossRefGoogle Scholar
Edelstein, Paul and Kilian, Lutz (2007) The response of business fixed investment to changes in energy prices: A test of some hypotheses about the transmission of energy price shocks. B.E. Journal of Macroeconomics (Contributions) 7, Article 35.CrossRefGoogle Scholar
Elder, John (2003) An impulse-response-function for a vector autoregression with multivariate GARCH-in-Mean. Economics Letters 79, 21–26.CrossRefGoogle Scholar
Elder, John (2004) Another perspective on the effects of inflation volatility. Journal of Money, Credit and Banking 36, 911–928.CrossRefGoogle Scholar
Elder, John and Serletis, Apostolos (2010) Oil price uncertainty. Journal of Money, Credit and Banking 42, 1138–1159.CrossRefGoogle Scholar
Gallant, Ronald A., Rossi, Peter E., and Tauchen, George (1993) Nonlinear dynamic structures. Econometrica 61 (4), 871–907.CrossRefGoogle Scholar
Gibson, Rajna and Eduardo, S. Schwartz (1990) Stochastic convenience yield and the pricing of oil contingent claims. Journal of Finance 45, 959–976.CrossRefGoogle Scholar
Hamilton, James D. (2003) What is an oil shock? Journal of Econometrics 113, 363–398.CrossRefGoogle Scholar
Hamilton, James D. (2008) Oil and the macroeconomy. In New Palgrave Dictionary of Economics, 2nd ed.London: Macmillan.Google Scholar
Hamilton, James D. (2009) Causes and consequences of the oil shock of 2007–08. Brookings Papers on Economic Activity 1, 215–261.CrossRefGoogle Scholar
Hamilton, James D. (2011) Nonlinearities and the macroeconomic effects of oil prices. Macroeconomic Dynamics [this issue].CrossRefGoogle Scholar
Hamilton, James D. and Herrera, Ana Maria (2004) Oil shocks and aggregate macroeconomic behavior: The role of monetary policy. Journal of Money, Credit and Banking 36, 265–286.CrossRefGoogle Scholar
Kellogg, R. (2010) The Effect of Uncertainty on Investment: Evidence from Texas Oil Drilling. NBER working paper 16541 (http://www.nber.org/papers/w16541).CrossRefGoogle Scholar
Kilian, Lutz (2008) The economic effects of energy price shocks. Journal of Economic Literature 46, 871–909.CrossRefGoogle Scholar
Kilian, Lutz and Vigfusson, Robert J. (2011) Nonlinearities in the oil price–output relationship. Macroeconomic Dynamics [this issue].CrossRefGoogle Scholar
Lee, Kiseok, Ni, Shawn, and Ratti, Ronald A. (1995) Oil shocks and the macroeconomy: The role of price variability. Energy Journal 16, 39–56.CrossRefGoogle Scholar
Majd, Saman and Pindyck, Robert S. (1987) Time to build, option value, and investment decisions. Journal of Financial Economics 18, 7–27.CrossRefGoogle Scholar