Volatility Spillover Effects in the Oil and Financial Market: Cross-Hedging in the US Oil Market and the Energy Pipeline Sector

This chapter will provide important insights into the linkages between the oil and financial markets and explore a new cross-hedging strategy to manage risk in the pipeline and energy sector market. Specifically, it will focus on examining the mean and volatility spillover effects between the US oil market, US stock market and the US Energy Pipeline Sector Index. Of particular interest is the impact of the recent liquidity crisis in the financial markets on volatility spillovers. Results demonstrate that both the US oil and stock markets have statistically significant volatility spillover effects on the US Energy Pipeline Sector. In addition, the volatility transmission from the US oil market and stock market to the US energy pipeline market increased after the 2007–2008 financial crisis. Furthermore, decreasing liquidity in the US financial market is associated with a statistically significant increase in volatility transmission between the markets. The analysis of the hedging strategy effectiveness shows that both in-sample and out-of-sample performance of the new cross-hedging strategy introduced in this chapter enhance the oil-stock hedging strategies proposed in previous studies [Basher and Sadorsky, 2016; Salisu and Oloko, 2015].