Energy sector uncertainty decomposition: New approach based on implied volatilities

The source(s) of uncertainty for energy sector companies is of interest for managers and investors, both trying to manage the uncertainty. In this paper, we suggest decomposing this uncertainty into crude oil and stock market uncertainty components. Using time-series data on implied volatility indexes, we estimate the weights of the components (55% and 45%, respectively) by applying a maximum likelihood method. We find that the model accounts for 69% of the variability in the changes of energy sector uncertainty. Furthermore, we report that during high public interest in crude oil, measured by internet interest using crude oil related search terms, the weight of the crude oil (stock market) component increases (decreases), but when the price of oil or implied volatilities of crude oil or stock markets are high, it decreases (increases). Thus, we contribute by showing how energy sector companies’ market uncertainty can be divided into separate components; by suggesting how the weights of the components can be estimated using implied volatilities; and by providing empirical evidence on the effects of public interest and general crude oil and stock market conditions on the obtained weights.