Abstract
A recent strand in the literature emphasizes the role of news-based economic policy uncertainty (EPU) and equity market uncertainty (EMU) as drivers of oil price movements. Against this backdrop, this paper uses a kth-order nonparametric quantile causality test, to analyse whether EPU and EMU predict stock returns and volatility. Based on daily data covering the period of 2 January 1986 to 8 December 2014, we find that, for oil returns, EPU and EMU have strong predictive power over the entire distribution barring regions around the median, but for volatility, the predictability virtually covers the entire distribution, with some exceptions in the tails. In other words, predictability based on measures of uncertainty is asymmetric over the distribution of oil returns and its volatility.
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Notes
Measuring volatility of a series as squared returns, especially related to the oil markets has been discussed in detail by Lux et al., (forthcoming, 2016).
Further details are available at: http://www.policyuncertainty.com/us_daily.html.
Further details are available at:http://www.policyuncertainty.com/equity_uncert.html.
Not surprisingly, standard unit root tests reveal that oil price is a unit root process, while oil returns is stationary. On the other hand, EMU and EPU are found to be stationary. Complete details on the unit root tests are available upon request from the authors.
Often referred to as the fear index or the fear gauge, it represents one measure of the Market’s expectation of stock market volatility over the next 30-day period.
As indicated at: http://www.policyuncertainty.com/equity_uncert.html, the EMU exhibits a contemporaneous daily correlation with the VIX of over 0.3.
There was no evidence of predictability running from oil returns to either EPU or EMU even at 10 % level of significance. Complete details of these results are available upon request from the authors.
We obtained qualitatively similar results when we used oil returns and volatility based on the Brent crude price covering the period of 21 May 1987 to 8 December 2014. These results are available upon request from the authors.
Oil returns are found to cause the mean of EPU from quantiles 0.25 and above, while its volatility is predicted over the entire conditional distribution. For EMU, oil returns predict the mean over the entire conditional distribution. As far as volatility of EMU is concerned, oil returns predict it adequately except around the median and upper quantiles, i.e., beyond 0.80. Note that as it is difficult to interpret economically what part of the variance of the uncertainty is implied, we keep these results restricted only to this footnote. Complete details of these results are available upon request from the authors.
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We would like to thank two anonymous referees for many helpful comments. However, any remaining errors are solely ours.
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Balcilar, M., Bekiros, S. & Gupta, R. The role of news-based uncertainty indices in predicting oil markets: a hybrid nonparametric quantile causality method. Empir Econ 53, 879–889 (2017). https://doi.org/10.1007/s00181-016-1150-0
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DOI: https://doi.org/10.1007/s00181-016-1150-0