Oil and Risk Premia in Equity Markets
Studies in Economics and Finance
Posted: 14 Nov 2019 Last revised: 26 Aug 2020
Date Written: November 6, 2019
We explore the oil-stock market nexus from a novel angle by examining the predictive role of oil prices over the excess returns associated with the market, size, book-to-market and momentum factors via bivariate cross-quantilograms. Our analysis of systematic risk premia across the four regions show that crude oil returns indeed capture predictive information regarding excess factor returns in stock markets, particularly those associated with market, size and momentum factors. However, the predictive power of oil return over excess factor returns is asymmetric and primarily concentrated on extreme quantiles, suggesting that large fluctuations in oil prices capture markedly different predictive information over stock market risk premia during up and down states of the oil market. The findings have significant implications for the profitability of factor or style based active portfolio strategies and suggest that the predictive information contained in oil market fluctuations could be utilized to enhance returns via conditional strategies based on these predictability patterns.
Keywords: Quantile, Correlogram, Predictability, Oil return, Risk premia
JEL Classification: C22, F31
Suggested Citation: Suggested Citation