Oil price thresholds and stock returns

ABSTRACT

In this article, we apply the threshold autoregressive model to examine oil price thresholds and the relationship between oil prices and the returns of 25 benchmark portfolios formed on size and book-to-market. Our results show that the relationship between the change in oil prices and portfolio returns reverses depending on whether the current oil price is above or below the estimated oil price threshold. Additional results show that this threshold effect is concentrated in the small stock portfolios. Finally, our finding that there is a threshold effect of oil price changes on stock returns is consistent with the theoretical model of investor sentiment presented by Barberis, Shleifer, and Vishny (1998) and is intuitively consistent with the economic dynamics and structure of the oil industry.

KEYWORDS:

• Oil price
• lagged returns
• threshold autoregressive model

ORCID

An-Sing Chen https://orcid.org/0000-0002-9927-4620

Che-Ming Yang https://orcid.org/0000-0001-7132-9776

Notes

1 The descriptions of the Fama-French (F-F) variables come from Ken French’s web site.

2 The results for value-weighted portfolios are similar. They are not presented in this paper to shorten the presentation.