Crude Awakening: Oil Prices and Bond Returns

47 Pages Posted: 15 Apr 2019 Last revised: 7 May 2019

See all articles by Eric Jondeau

Eric Jondeau

University of Lausanne - Faculty of Business and Economics (HEC Lausanne); Swiss Finance Institute

Qunzi Zhang

Shandong University

Xiaoneng Zhu

Shanghai University of Finance and Economics

Date Written: April 15, 2019

Abstract

Oil price changes fail to predict asset returns because they are too noisy. We construct an oil trend factor that fi lters out noise and provide evidence that it predicts bond risk premiums well. This result holds in developed and emerging markets, both in sample and out of sample. Notably, the oil trend factor improves predictions based on current term structure predictors, such as the first three principal components of yields and the Cochrane and Piazzesi (2005) factor. A puzzle emerging from our results is that oil price increases, which are generally thought to precede economic recessions, are in fact associated with subsequent lower bond returns. To solve this puzzle, we demonstrate that not all oil price shocks are alike: Although oil demand and supply shocks have opposite implications for economic activity and bond risk premiums, the oil trend factor is mainly related to demand shocks. Therefore, increases in the oil trend tend to signal a strong economy and lower bond returns.

Keywords: bond risk premium, demand shocks, oil prices, return predictability

JEL Classification: G11, G12, G15, P36

Suggested Citation

Jondeau, Eric and Zhang, Qunzi and Zhu, Xiaoneng, Crude Awakening: Oil Prices and Bond Returns (April 15, 2019). Swiss Finance Institute Research Paper No. 19-24. Available at SSRN: https://ssrn.com/abstract=3372204 or http://dx.doi.org/10.2139/ssrn.3372204

Eric Jondeau (Contact Author)

University of Lausanne - Faculty of Business and Economics (HEC Lausanne) ( email )

Extranef 232
Lausanne, 1012
Switzerland
+41 21 692 33 49 (Phone)

HOME PAGE: http://www.hec.unil.ch/ejondeau/

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Qunzi Zhang

Shandong University ( email )

27 Shanda Nanlu
South Rd.
Jinan, Shandong 250100
China

HOME PAGE: http://www.econ.sdu.edu.cn/tree/content.php?id=52869

Xiaoneng Zhu

Shanghai University of Finance and Economics ( email )

777 Guoding Road
Shanghai, AK Shanghai 200433
China

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