Uncertainty and sign-dependent effects of oil market shocks

This paper investigates the oil market reaction to its fundamental shocks: supply,
aggregate demand and oil-specific demand in different regimes characterised by high
versus low uncertainty in the market. We do so by first proposing a novel oil uncertainty
index that is measured by the conditional volatility of the unpredictable component of oil
prices. Then, we employ a nonlinear model to show that the structural oil market shocks
have asymmetric effects. For instance, in relation to real economic activity, we find that
both supply shocks and oil-specific demand shocks have negligible impacts in periods of
low oil price uncertainty but sizeable effects in periods of high oil price uncertainty. Our
model also enables us to evaluate the hypothesis that real economic activity responds
asymmetrically to unexpected increases and decreases in oil prices driven by supply and
specific demand shocks. We find that the effects of oil supply shocks are asymmetric but
oil specific demand shocks are not, which indicates that the (a)symmetric oil market
reaction depends on the underlying market shocks.