Oil and Equity Return Predictability: The Importance of Dissecting Oil Price Changes

79 Pages Posted: 15 Aug 2016 Last revised: 8 Nov 2018

See all articles by Haibo Jiang

Haibo Jiang

Tulane University

Georgios Skoulakis

University of British Columbia (UBC) - Division of Finance

Jinming Xue

University of Maryland - Department of Finance

Date Written: November 7, 2018

Abstract

Based on data until the mid 2000s, oil price changes were shown to predict international equity index returns with a negative predictive slope. Extending the sample to 2015, we document that this relationship has been reversed over the last ten years and therefore has not been stable over time. We then posit that oil price changes are still useful for forecasting equity returns once complemented with relevant information about oil supply and global economic activity. Using a structural VAR approach, we decompose oil price changes into oil supply shocks, global demand shocks, and oil-specific demand shocks. The hypothesis that oil supply shocks and oil-specific demand shocks (global demand shocks) predict equity returns with a negative (positive) slope is supported by the empirical evidence over the 1986-2015 period. The results are statistically and economically significant and do not appear to be consistent with time-varying risk premia.

Keywords: Equity Return Predictability; Structural VAR Model; Oil Price Change Decomposition; Oil Supply Shock; Global Demand Shock; Oil-Speci

JEL Classification: C53; G10; G12; G14; E44; Q41

Suggested Citation

Jiang, Haibo and Skoulakis, Georgios and Xue, Jinming, Oil and Equity Return Predictability: The Importance of Dissecting Oil Price Changes (November 7, 2018). Robert H. Smith School Research Paper No. RHS 2822061; Paris December 2018 Finance Meeting EUROFIDAI - AFFI. Available at SSRN: https://ssrn.com/abstract=2822061 or http://dx.doi.org/10.2139/ssrn.2822061

Haibo Jiang

Tulane University ( email )

A.B. Freeman School of Business
7 McAlister Drive
New Orleans, LA 70118
United States
504-314-2492 (Phone)

Georgios Skoulakis (Contact Author)

University of British Columbia (UBC) - Division of Finance ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2
Canada

Jinming Xue

University of Maryland - Department of Finance ( email )

Robert H. Smith School of Business
Van Munching Hall
College Park, MD 20742
United States

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