The relationship between oil prices and stock/bond market: a sectoral analysis

Abstract

While numerous studies have investigated the impact of oil prices on the stock market, Chapter 2 is the first to examine the association between corporate bond yields and oil returns. We examine the association between oil-returns and corporate bond yields of four major U.S. industrial and financial sectors (including thirteen sub-sectors). Chapter 3 examines the reaction of stock markets in the U.K. and the Netherlands to a major composite event in the oil industry – the merger of the Royal Dutch Shell (RDSA) and the BG Group (BRGYY) on April 8, 2015, and the subsequent discovery of oil in southern England on April 9. We employ an exponential autoregressive conditionally heteroskedastic (EGARCH (1, 1)) framework in both Chapters, which allows for asymmetry of the effects between positive and negative external shocks including oil return shocks, shows the effects on both the yields/stock returns and their volatilities, and permits the persistence of the shocks to be measured. Three main results are obtained in Chapter 2. First, oil returns are significantly associated with the yield levels of corporate bonds issued in ten out of the thirteen sub-sectors considered within the oil-substitute, oil-related, oil-user, and financial services sectors. The three exceptions are the Petroleum Refinery, Building, and Chemical sub-sectors. Second, the return volatilities of corporate bonds issued in the Plastic & Rubber sub-sector demonstrate asymmetric responses to positive and negative shocks. To elaborate, negative shocks lead to lower volatility in the Plastic & Rubber sub-sector than positive shocks of the same magnitude. Third, the half-life, or the time it takes for the volatility of the portfolio of bonds in the Industrial Machinery sub-sector to move halfway back to its conditional mean after a shock is introduced, is 8.6 months. For bonds in all other sub-sectors, the half-life is less than 2.5 months. We obtain several results in Chapter 3. First, the composite event of merger and oil discovery generated significant abnormal returns in six out of the thirteen sub-sectors considered in the U.K. and three out of ten sub-sectors in the Netherlands. The remaining seven sub-sectors in the U.K. and the other seven sub-sectors in the Netherlands show no sensitivity in returns to the shock. Second, there is evidence of some information leakage about the composite event as demonstrated in the significant abnormal returns for Coal, Oil & Gas Extraction, Depository Institute, Chemical and Plastic & Rubber sub-sectors in U.K. and Coal, Depository Institute and Air Transportation sub-sectors in the Netherlands up to three days before the announcement of the composite event. Third, the behavioral patterns of four of the thirteen sub-sectors considered in the U.K. and four of the ten sub-sectors considered in the Netherlands demonstrate asymmetry in response to external shocks to their respective returns. These results have three main implications. First, investors holding bonds issued by the two sub-sectors with asymmetric oil shock effects need to add bonds from oil-related and oil-substitute sectors to lower the volatility of their bond portfolio because the latter do not exhibit asymmetry. Second, considering the overall finding of sensitivity to oil price changes, institutional investors need to examine the sensitivity of their bond portfolios to oil return changes and to guard against excessive risk. Similarly, corporations should monitor oil price variations and hedge the volatility risk accordingly. Finally, stock investors in the U.K. and the Netherlands might benefit from monitoring the key events that may affect the oil supply and oil prices, and acting accordingly.