The equity-oil hedge: A comparison between volatility and alternative risk frameworks

This paper investigates alternatives to the conventional minimum-variance framework for hedging equity risks with crude oil. Specifically, the optimal hedge ratios are calculated for various risk objectives such as volatility, semivariance, and tail risk. The hedging efficacy is assessed for BRIC stocks and aggregated market indices. The results show that the optimal hedge ratios differ by strategy, and hedging efficacy varies across risk metrics, equity indices, and time periods. Semivariance and tail risk hedging are more effective than volatility risk hedging, but more expensive. Oil exporters (Brazil and Russia) outperform importers (India and China) in terms of hedging effectiveness. Hedging costs are lower during COVID-19 than during the global financial crisis. It is critical to capture volatility dynamics for hedging volatility, downside, and tail risk. Over-hedging could significantly increase the risk of an equity-oil-hedged portfolio. The findings contribute to a better understanding of oil’s risk hedging capacity for equity indices, which will be of interest to financial market participants, corporations, and regulators.