Oil and Equity Return Predictability: The importance of dissecting oil price changes

Speaker: Dr Georgios Skoulakis is an Assistant Professor in the Finance division of the Sauder School of Business at the University of British Columbia, and an IFFR Fellow. His research focuses on empirical asset pricing, financial econometrics, and portfolio choice. His publications have appeared in journals such as the Journal of Financial Economics, Review of Financial Studies, Journal of Econometrics, Journal of Business and Economics Statistics, and the Mathematics and Financial Economics. Dr Skoulakis holds a Ph.D. in Finance from Northwestern University and a Ph.D in Statistics from the University of North Carolina at Chapel Hill.

Abstract

Based on data until the mid-2000s, oil price changes were shown to predict international equity index returns with a negative predictive slope. Extending the sample to 2015, we document that this relationship has been reversed over the last ten years and therefore has not been stable over time. We then posit that oil price changes are still useful for forecasting equity returns once complemented with relevant information about oil supply and global economic activity. Using a structural VAR approach, we decompose oil price changes into oil supply shocks, global demand shocks, and oil-specific demand shocks. The hypothesis that oil supply shocks and oil-specific demand shocks (global demand shocks) predict equity returns with a negative (positive) slope is supported by the empirical evidence over the 1986-2015 period. The results are statistically and economically significant and do not appear to be consistent with time-varying risk premia.