Betting on war? Oil Prices, Stock Returns and Extreme Geopolitical Events

Abstract

We show that the ability of oil price changes to predict stock returns is limited to periods of extreme geopolitical unrest. Four events generate most of the predictability: the 1973 Arab-Israel war, the 1986 OPEC collapse, the 1990/91 Persian gulf war, and the 2003 invasion of Iraq. We also find that a market-timing trading strategy based on oil price changes typically generates insignificant abnormal returns, contradicting previously published results. Our findings serve as an example of how a significant predictor in a time series forecasting regression may not be a useful or profitable market-timing signal.

Keywords: Return predictability, Oil prices, International stock markets, Market eciency, Stock returns JEL classication: G11, G14, G15, G17

JEL Classification: G11, G14, G15, G17