Sectoral Stock Return Sensitivity to Oil Price Changes: A Double-Threshold FIGARCH Model
Quantitative Finance, 2013, Vol. 13, No. 4, 593–612
Posted: 18 Jun 2014
Date Written: July 12, 2011
We investigate the association between the stock return distributions of 10 major U.S. sectors and oil returns within a double-threshold FIGARCH model. This model nests GARCH, IGARCH and Fama-French specifications as its special cases and allows a test of their validity. This model also has the advantage of capturing not only the short-run dynamics (as in the standard GARCH model), but also the long-run persistence pattern of oil shock effects that may decay at a slower hyperbolic pace. We find that: (i) data reject the more restricted GARCH, IGARCH and Fama-French models in favor of FIGARCH, (ii) oil return is a significant determinant of every sector’s return and/or return volatility, (iii) oil effects are asymmetric for oil returns above and below the thresholds, (iv) asymmetry is stronger when oil return volatility is greater, (v) volatilities of sectoral returns exhibit threshold-based regime shifts, and (vi) oil shock effects follow a hyperbolic, rather than an exponential decay pattern, establishing long-term persistence of shocks. Policy implications are drawn.
Keywords: Oil price, Sector returns, Threshold, FIGARCH
JEL Classification: G1, G12
Suggested Citation: Suggested Citation