The Diminishing Hedging Role of Crude Oil: Evidence From Time Varying Financialization

Abstract

Using daily data from 1999 to 2019, we document a diminishing hedging role that crude oil plays for the stock market as a result of growing financialization. With interest rates driven near zero after the crisis of 2007-2009 and the extreme volatility of oil prices, vector auto-regressions (VARs) suggest larger roles of oil prices in explaining stock returns during the 2007-2009 crisis and afterwards. We also find increased co-movement between stock-oil during post-crisis period. Our results indicate that more short positions in crude oil are required to hedge long positions in equity markets during post-crisis period, i.e., it cost more to use crude oil investments as a hedging tool lately compared to pre-crisis period. Therefore, investors holding a mixed portfolio of stocks and oil face less diversification.

Keywords: Crisis, Crude Oil, Financialization, Hedging, Stock Markets

JEL Classification: G1, G4, G11