Stock Return Predictability and Oil Prices

Jaime Casassus () and Freddy Higuera

No 406, Documentos de Trabajo from Instituto de Economia. Pontificia Universidad Católica de Chile.

Abstract: This paper shows that oil price changes, measured as short-term futures returns, are a strong predictor of excess stock returns at short horizons. Ours is a leading variable for the business cycle and exhibits low persistence which avoids the ctitious long-horizon predictability associated to other predictors used in the literature. We compare our variable with the most popular predictors in a sample period that includes the recent nancial crisis. Our results suggest that oil price changes are the only variable with forecasting power for stock returns. This signi cant predictive ability is robust against the inclusion of other variables and out-of-sample tests. We also study the cross-section of expected stock returns in a conditional CAPM framework based on oil price shocks. Our model displays high statistical signi cance and a better t than all the conditional and unconditional models considered including the Fama French three-factor model. From a practical perspective, ours is a high-frequency, observable variable that has the advantage of being readily available to market-timing investors.

Keywords: Return predictability; business cycle; crude oil; futures prices; asset pricing; conditional CAPM (search for similar items in EconPapers)
JEL-codes: E32 E44 G12 G14 G17 Q43 (search for similar items in EconPapers)
Date: 2011
New Economics Papers: this item is included in nep-ene, nep-fmk and nep-for
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

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Persistent link: https://EconPapers.repec.org/RePEc:ioe:doctra:406

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