Fresh evidence on the oil-stock interactions under heterogeneous market conditions

This paper ameliorates the existing empirical literature on the oil-stock nexus in three ways. First, we expand the literature on return-volatility interactions by adding non-linear dimensions to it. Second, we propose a threshold VAR asymmetric GARCH-in-mean (TVAR-AGARCH-M) model to examine the mean-spillover and return-volatility associations under heterogeneous market conditions of bull and bear markets. Third, we show that the TVAR-AGARCH-M model is superior to the benchmark VAR-GARCH-M model. Our analysis unfolds that oil price volatility affects stock returns in highly volatile market conditions but not in low-volatile states. We also find evidence of strong asymmetry wherein lagged negative shocks strongly influence volatility in oil and stock markets. Specifically, we show that countries such as Japan can benefit from hedging in international markets by diversifying their portfolio in positively correlated markets.