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Stock Return Predictability and Oil Prices

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  • Jaime Casassus
  • Freddy Higuera

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.

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Bibliographic Info

Paper provided by Instituto de Economia. Pontificia Universidad Católica de Chile. in its series Documentos de Trabajo with number 406.

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Date of creation: 2011
Date of revision:
Handle: RePEc:ioe:doctra:406

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Keywords: Return predictability; business cycle; crude oil; futures prices; asset pricing; conditional CAPM;

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References

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Cited by:
  1. Francesco Ravazzolo & Marco J. Lombardi, 2012. "Oil price density forecasts: Exploring the linkages with stock markets," Working Papers 0008, Centre for Applied Macro- and Petroleum economics (CAMP), BI Norwegian Business School.
  2. Jaime Casassus & Freddy Higuera, 2013. "The Economic Impact of Oil on Industry Portfolios," Documentos de Trabajo 433, Instituto de Economia. Pontificia Universidad Católica de Chile..
  3. Marco Jacopo Lombardi, 2013. "On the correlation between commodity and equity returns: implications for portfolio allocation," BIS Working Papers 420, Bank for International Settlements.

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