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Estimating Oil Risk Factors Using Information from Equity and Derivatives Markets

52 Pages Posted: 14 May 2012 Last revised: 13 Dec 2013

I-Hsuan Ethan Chiang

University of North Carolina (UNC) at Charlotte

W. Keener Hughen

Sacred Heart University

Jacob S. Sagi

University of North Carolina Kenan-Flagler Business School

Date Written: November 18, 2013

Abstract

We introduce a novel approach to estimating latent oil risk factors and establish their significance in pricing non-oil securities. Our model, which features four factors with simple economic interpretations, is estimated using both derivative prices and oil-related equity returns. The fit is excellent in and out of sample. The extracted oil factors carry significant risk premia, and are significantly related to macroeconomic variables as well as portfolio returns sorted on characteristics and industry. The average non-oil portfolio exhibits a sensitivity to the oil factors amounting to a sixth (in magnitude) of that of the oil industry itself.

Keywords: Oil, futures, asset pricing, APT, real options, CAPM, Fama-French factors, Markov chain Monte Carlo

JEL Classification: G12, G13

Suggested Citation

Chiang, I-Hsuan Ethan and Hughen, W. Keener and Sagi, Jacob S., Estimating Oil Risk Factors Using Information from Equity and Derivatives Markets (November 18, 2013). Journal of Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2058558 or http://dx.doi.org/10.2139/ssrn.2058558

I-Hsuan Ethan Chiang

University of North Carolina (UNC) at Charlotte ( email )

9201 University City Boulevard
Charlotte, NC 28223
United States

W. Keener Hughen

Sacred Heart University ( email )

5151 Park Ave
Fairfield, CT 06432
United States

Jacob Sagi (Contact Author)

University of North Carolina Kenan-Flagler Business School ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States

HOME PAGE: http://public.kenan-flagler.unc.edu/faculty/sagij/

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