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Do oil futures prices predict stock returns?

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  • Chiang, I-Hsuan Ethan
  • Hughen, W. Keener

Abstract

This paper explores stock return predictability by exploiting the cross-section of oil futures prices. Motivated by the principal component analysis, we find the curvature factor of the oil futures curve predicts monthly stock returns: a 1% per month increase in the curvature factor predicts 0.4% per month decrease in stock market index return. This predictive pattern is prevailing in non-oil industry portfolios, but is absent for oil-related portfolios. The in- and out-of-sample predictive power of the curvature factor for non-oil stocks is robust and outperforms many other predictors, including oil spot prices. The predictive power of the curvature factor comes from its ability to forecast supply-side oil shocks, which only affect non-oil stocks and are hedged by oil-related stocks.

Suggested Citation

  • Chiang, I-Hsuan Ethan & Hughen, W. Keener, 2017. "Do oil futures prices predict stock returns?," Journal of Banking & Finance, Elsevier, vol. 79(C), pages 129-141.
    • Handle: RePEc:eee:jbfina:v:79:y:2017:i:c:p:129-141
    DOI: 10.1016/j.jbankfin.2017.02.012
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    More about this item

    Keywords

    Oil; Futures; Predictability; Curvature; Supply shocks; Futures curve;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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