The Time-varying Relationship between Oil Prices and Stock Returns: Evidence from Oil-importing and Oil-exporting Countries

Abstract

This paper studies the relationship between oil prices and stock markets of four oil-importing and six oil-exporting countries. Monthly data is used for the period March 1983- December 2020. First, a rolling-window regression model is used to establish the time-varying contemporaneous relationship between WTI futures prices and the stock indices. The industrial production index is included as a variable to control for global growth. Second, we test whether investors react with a delay to oil price changes as hypothesised by Hong and Stein (1999). Our findings suggest that there is a significant relationship for all countries at least at some point in time. The oil-exporting countries generally show a significantly positive relationship, consistent with the theoretical expectations. The oil-importing countries show less homogeneous results. The results of our second test provide evidence for underreaction behaviour of investors, as the oil effect strengthens once we include lags of several trading days between monthly oil prices and stock returns. Moreover, we demonstrate that trading strategies based on the oil effect generate superior gains in comparison with buy-and-hold strategy.