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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.
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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

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