Oil Jump Risk

44 Pages Posted: 10 May 2018 Last revised: 18 Dec 2018

See all articles by Nima Ebrahimi

Nima Ebrahimi

University of Houston-Department of Finance

Date Written: August 31, 2018

Abstract

We show that the innovation in the risk-neutral probability of large downward and upward jumps in oil prices has a considerable predictive power for important economic indicators such as GDP growth, consumption growth, and total investment. In addition, we observe that the upside jump risk probability is a significant predictor of stock market index return and the returns of oil futures. Furthermore, the upside jump probability is a significant and relatively strong predictor of oil market fundamentals including inventory growth, demand growth, and OPEC’s production growth. Upside jump risk is also a driver of the cross-section of stock returns before the U.S. oil production increase in 2011. The average monthly return for the high-low upside jump risk exposure portfolio is -0.94% and -1.13%, using the 1996-2014 and 1996-2011 time periods respectively. The implications of the variance risk for the cross-section of stock returns vanishes after controlling for the large upside and downside jump risks. The shale revolution and considerable increase of the US oil production have killed the effect of upside risk premium after 2011. During the sub-period 2011-2014, the variance risk premium gets significant again, like it was before 2000.

Keywords: Jump Risk, Delta-Vega Neutral Portfolio, Delta-Gamma Neutral Portfolio, Cross-Section

JEL Classification: G11, G12, G13

Suggested Citation

Ebrahimi, Nima, Oil Jump Risk (August 31, 2018). Available at SSRN: https://ssrn.com/abstract=3168263 or http://dx.doi.org/10.2139/ssrn.3168263

Nima Ebrahimi (Contact Author)

University of Houston-Department of Finance ( email )

Houston, TX
United States
6784687058 (Phone)

HOME PAGE: http://https://www.bauer.uh.edu/search/directory/profile.asp?firstname=Nima&lastname=Ebrahimi

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