Oil Volatility Risk and Expected Stock Returns
54 Pages Posted: 23 Feb 2014 Last revised: 4 Dec 2014
Date Written: December 2, 2014
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: Suggested Citation