Oil Volatility Risk and Expected Stock Returns

54 Pages Posted: 23 Feb 2014 Last revised: 4 Dec 2014

Peter Christoffersen

University of Toronto - Rotman School of Management; Copenhagen Business School; University of Aarhus - CREATES

Xuhui (Nick) Pan

Tulane University

Date Written: December 2, 2014

Abstract

After the financialization of commodity futures markets in 2004-05 oil volatility has become a strong predictor of returns and volatility of the overall stock market. Furthermore, stocks' exposure to oil volatility risk now drives the cross-section of expected returns. The difference in average return between the quintile of stocks with low exposure and high exposure to oil volatility is significant at 0.66% per month, and oil volatility risk carries a significant risk premium of -0.60% per month. In the post-financialization period, oil volatility risk is strongly related with various measures of funding liquidity constraints suggesting an economic channel for the effect.

Keywords: option-implied volatility; oil prices; volatility risk; cross-section; factor-mimicking portfolios; financial intermediaries

JEL Classification: G12, G13, E44, Q02

Suggested Citation

Christoffersen, Peter and Pan, Xuhui (Nick), Oil Volatility Risk and Expected Stock Returns (December 2, 2014). Rotman School of Management Working Paper No. 2399677. Available at SSRN: https://ssrn.com/abstract=2399677 or http://dx.doi.org/10.2139/ssrn.2399677

Peter Christoffersen (Contact Author)

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5P 3C4
Canada
416-946-5511 (Phone)

HOME PAGE: http://www.christoffersen.com

Copenhagen Business School

Solbjerg Plads 3
Frederiksberg C, DK - 2000
Denmark

University of Aarhus - CREATES

School of Economics and Management
Building 1322, Bartholins Alle 10
DK-8000 Aarhus C
Denmark

Xuhui (Nick) Pan

Tulane University ( email )

7 McAlister Dr.
New Orleans, LA 70118
United States

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