Co-movements Between Stock and Oil Markets

Abstract

Our study is an analysis of the characteristics of stock-oil hedges. We have used a comprehensive sample of international stock market indices both from developed as well as emerging countries and Brent oil as the key energy asset. Our results indicate that the hedge ratios of major stock market indices are time-varying and have significantly increased after the GFC. Apart from studying hedge ratios and effectiveness, this study has contributed to the literature by identifying those factors that actually drive hedge portfolio returns. Despite the hedge ratios differing among the various indices, we have identified two common drivers of hedge portfolio returns: the most important driver is the changes in the VIX, significant in all markets; the second major driver is changes in the USD/EUR spot rate. Hedge portfolio returns are related negatively to both of these variables. In addition, we find that since the GFC hedge effectiveness has increased and hedge portfolio returns are additionally influenced by gold returns and changes in the term structure. Our findings are important for portfolio managers, especially during periods of market stress, since they can use this information to further improve their hedging performance.