A wavelet-based methodology to compare the impact of pandemic versus Russia-Ukraine conflict on crude oil sector and its interconnectedness with other energy and non-energy markets

Journal: Energy Economics

In the context of two of the most crucial incidents of this decade, the COVID-19 pandemic and the Russia-Ukraine conflict, the authors address the important question of whether the economic impacts of these two events are the same on various energy and non-energy assets. 

Their study focuses on a comparative analysis of the S&P500 index, bitcoin, gold, crude oil (Brent and WTI) and natural gas market in terms of their market efficiency and interconnectedness during the pandemic and the war. 

They deploy a novel methodology that utilizes the wavelet decomposition of time series, which facilitates capturing information both in the time and frequency domain. They begin with analyzing the market efficiency behavior with the help of a combined index based on information gathered from several time scales. Next, the inter-dynamics of the markets are studied separately for different investment horizons. They study the market interconnectedness through wavelet coherence, while the return and volatility spillover are analyzed using a VAR and vector-valued GARCH model, respectively.

Their analysis suggests that the energy sector is impacted more than the non-energy sector in times of both the crises, although the nature of the impact is different. Interestingly, the energy market is more vulnerable in terms of market efficiency during both war and pandemic as compared to the assets of the non-energy market. The crude oil sector, in particular, seems to be more affected by the crises than natural gas. In terms of efficiency, bitcoin suffers the least during both crises while gold endures slightly only during the pandemic, thereby supporting the existing literature on gold and bitcoin being regarded as safe assets in times of economic turmoil. S&P500, in comparison, seems to be affected by both the events, although the impacts persist only for a brief period before the market starts to retain its efficiency. All the markets other than crude oil appear to be in a recovering state from the Russia-Ukraine crisis in recent times.

On the other hand, regarding spillover dynamics and interconnectedness, they observe higher co-movement in lower frequency regions and higher spillover in higher frequency scales. The crude oil sector interacts the most between each other, both in terms of price and volatility spillover. In fact, volatility spillover seems to increase around the time of the war at times. Despite being an energy sector asset, natural gas shows similar volatility spillover with both the crude oils. The stock market and the bitcoin market are generally found to be the transmitters of volatility spillover towards both Brent and WTI during the pandemic, but often the asymmetric effects spillover seem to increase between the crude oils (especially WTI) and gold around the time of the war.

Since the market states matter more than an investment decision in corporate investments, understanding the reaction of each of the markets to different types of crises is of equal importance to investors and policy makers. To that end, the authors believe the results of this study would help investors to choose a safe market and plan their portfolio accordingly during a crisis. Further, from a methodological standpoint, they believe that the use of wavelet decomposition in a unified framework to analyze different aspects of markets can potentially be extended effectively in similar economic studies.