Most of the previous studies focused on Supply and demand variables and indicated that

fundamental factors are the key drivers of oil prices (Chevillon and Rifflart, 2009; Isabel
Vansteenkiste, 2011; Kilian, 2009). Demand shock have positive effect on oil price (Kilian and
Lee, 2014; Kilian, 2009). Cuts in OPEC quota leads to increase in oil prices and increase or
stagnant OPEC quota tend to have negative effect on oil price (Chevillon and Rifflart, 2009; Lin
and Tamvakis, 2010). Contemporary Research in the field of oil price dynamics indicates that the
speculative factors and financial factors also have significant impact on oil price apart from
fundamental factors.
Financial factors such as exchange rate and stock returns determine the crude oil price (Amano
and Van Norden, 1998; Narayan et al., 2008; Basher et al., 2012; Beckmann and Czudaj, 2013;
Wang and Wu, 2012). Increase in emerging market stock prices increases oil prices (Basher et
al., 2012). Moreover, the stock returns of large oil producing and consuming countries have
relatively strong dependence with oil price (Sukcharoen et al., 2014). Speculative trading can
influence the oil prices without any change in fundamental factors (Hamilton, 2008). Sornette et
al. (2009) postulated that the oil price shocks during crisis are due to speculative factors.
Some studies argue that fundamental factors play major role compared to speculative factors
(Breitenfellner et al., 2009; Fan and Xu, 2009). Whereas other studies suggested that speculative
factors play a significant role compared to fundamental in the oil market (Askari and Krichene,
2008; Cifarelli and Paladino, 2010, Sornette et al., 2009). Hence, it is required to determine the
drivers of crude oil in different market phases to understand the oil price dynamics.
To ascertain the effect of fundamental factors, we have used the variables such as OPEC
production, OECD stocks, OECD Net Imports. The major demand for oil comes from emerging
economies and OCED countries. To estimate the demand from OECD countries we consider
OECD consumption. Since the consumption data for the emerging economies is non-existing,
Industrial production of China (in $) and industrial production of India (in $) is considered as
proxy for the demand from emerging countries. However, variables such as industrial production
of China (in $) and industrial production of India (in $) were not used in the literature. We find
the relative effect of the variables across periods of low and high volatility.

Existing literature used financial variables such as S&P 500 (Cifarelli and Paladino, 2010), Realemerging equity prices (Basher et al., 2012), Dollar Index (Basher et al., 2012), NEER, REER
(Breitenfellner et al., 2009), Lagged oil price (Breitenfellner et al., 2009), OPEC implicit price
target (Chevillon and Rifflart, 2009). In our study, we have included financial variables such as
S&P 500, Dollar Index and a 12-month basis. In order to capture the speculative effect we have
included non-commercial net long position (both futures and options), as existing net long
position influences the price movements of the security.
Most of the existing literature examined this relationship majorly using traditional linear time
series models such as VAR/ VECM, co-integration and structural VAR. Oil price is also found to
have Breaks and long-run relationship in the variables (Miller and Ratti, 2009). Hence these
linear models suffer from possible misspecification or omitted variable bias. Moreover, the
relationship between oil price and other determinants may vary over time. Incorporating or using
the model, which accounts for structural break and the effect could change at different periods
would help in accurate estimation of oil price.
Very few studies have used nonlinear models such as CCC - GARCH-M and Bayesian Model
averaging. However, these models cannot estimate the relationship with respect to different
market phases; also, they fail to address breaks. Markov-regime switching methodology is
largely used for finding non-linear causality (Firouz Fallahi, 2011) and enables one to estimate
the relationships at different regimes. Hence, the study used Markov regime switching model to
investigate the nonlinear relationship between the crude oil and its determinants at different
regimes.