Academic journal article Economic Inquiry

Forecasting Crude Oil Price Movements with Oil-Sensitive Stocks

Academic journal article Economic Inquiry

Forecasting Crude Oil Price Movements with Oil-Sensitive Stocks

Article excerpt

I. INTRODUCTION

This paper uses monthly data from 1984:M10 to 2012:M8 to investigate the predictive content of oil-sensitive stock price indices for both nominal and real spot crude oil prices in both in- and out-of-sample tests. As stock prices are not subject to revision, the proposed variable, which reflects timely market information and is readily available, can potentially be a valuable predictor, and thereby help to improve the accuracy of forecasts of the price of crude oil.

Given that crude oil price is one of the key variables in forecasting macroeconomic aggregates, including real GDP and inflation (see the discussion in Kilian and Vigfusson 2011a, 2011b, 2013 and Kilian and Lewis 2011), the forecasting of crude oil prices has become the focus of many economists and decision makers (see Alquist, Kilian, and Vigfusson 2013). The recent literature has already explored the forecasting ability of a number of predictors for the price of oil, including the oil futures price, oil inventories, the price of crack spread futures, the price of industrial raw materials (other than crude oil), the dollar exchange rate of major broad-based commodity exporters, U.S. and global macroeconomic aggregates, and expert survey forecasts (see Alquist and Kilian 2010; Ye, Zyren, and Shore 2005, 2006; Murat and Tokat 2009; Reeve and Vigfusson 2011; Chen, Rogoff, and Rossi 2010; Baumeister and Kilian 2012a, 2012b, 2013; Alquist, Kilian, and Vigfusson 2013, and the references therein).

The novelty of this paper is to propose a new leading indicator, namely, oil-sensitive stock price indices, to forecast the price of crude oil instead. This predictor is motivated by the close link between the stock and oil markets already documented in the existing literature. Research into the oil price-stock price nexus has been increasing in recent years. (1) For example, see Driesprong, Jacobsen, and Maat (2008), Nandha and Faff (2008), and Park and Ratti (2008). Flowever, the relationship between oil prices and stock returns is unstable when one does not control for the composition of oil demand and supply shocks, as emphasized in recent work by Kilian and Park (2009). They show that the response of aggregate U.S. real stock returns may differ depending on whether the increase in the price of crude oil is driven by demand or supply shocks in the crude oil market. In other work, Apergis and Miller (2008) modify Kilian and Park's (2009) methodology and investigate data from Australia and G7 countries. They find evidence that different oil market structural shocks play a significant role in explaining adjustments in stock returns, although the magnitude of such effects proves to be small. Elsewhere, Narayan and Sharma (2011) find evidence that lagged oil prices are able to forecast stock returns using returns for 560 U.S. companies listed on the New York Stock Exchange (NYSE), while Elyasiani, Mansur, and Odusami (2011) show that oil price fluctuations constitute systematic asset price risk at the industry level. Lastly, Scholtens and Yurtsever (2012) investigate the dynamic link between oil prices and stock returns at the industry level in the Eurozone and conclude that the oil-stock price relationship differs substantially across industries.

Most studies focus on predicting stock returns using oil prices, with only a few attempting to examine the predictive content of stock returns on the price of crude oil. Hammoudeh and Aleisa (2004) present evidence that the Saudi stock index can predict New York Mercantile Exchange (NYMEX) oil futures prices, while the empirical findings in Zhang and Wei (2011) suggest that stock market risk in some developed countries (the United States, the United Kingdom, and Japan) is able to forecast international crude oil returns constructed using the West Texas Intermediate (WTI) futures price.

However, to the best of our knowledge, no existing study examines the forecasting content of stock price indices on predicting spot oil prices via in- and out-of-sample tests. …

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