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The role of intermediary capital risk in predicting oil volatility

Libo Yin

International Journal of Finance & Economics, 2022, vol. 27, issue 1, 401-416

Abstract: This paper aims to investigate the ability of market‐based intermediary capital risk to predict the volatility of crude oil futures. Using shocks to the market‐based intermediary capital ratio (IC_RF) of primary dealers as a predictor, this paper shows that IC_RF exhibits statistically and economically significant predictive power for the volatilities of crude oil futures, from both in‐sample and out‐of‐sample perspectives. The revealed predictability is also of economic significance, because it enables examining of the performance of portfolios that are constructed on IC_RF‐based forecasts of oil volatility. Additionally, IC_RF contains robust predictive power beyond what is embedded in traditional fundamental variables. Further analysis provides solid evidence supporting the superiority of asymmetric and regime change models over linear specifications in forecasting oil realized volatility, and it only provides weak evidence for implied oil volatility.

Date: 2022
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International Journal of Finance & Economics is currently edited by Mark P. Taylor, Keith Cuthbertson and Michael P. Dooley

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