Abstract
This paper empirically investigates the interdependence between GCC stock market and oil price by considering structural breaks in conditional volatility. The univariate and multivariate GARCH models are extended by including structural breaks which are determined endogenously by using ICSS algorithm proposed by Inclan and Tiao. Empirical results indicate that the inclusion of structural breaks in the model substantially reduces the volatility persistence and the estimated half-life of shocks. Hence, the conditional volatility of oil price and stock market are more affected by their own shocks and volatility when structural breaks are neglected. Likewise, our results are conclusive on conditional dependency between GCC stock market and oil price revealing that the volatility shifts reduce the shocks and volatility spillover effects. For the portfolio management, the empirical results show evidence of sensitivity of the optimal weight and hedge ratios to structural breaks in conditional volatility. Key words: GCC stock market, oil price, dependency, multivariate GARCH, structural breaks, ICSS algorithm, portfolio implications.
Highlights
An abundant literature has investigated the volatility linkage between stock markets (Lieven, 2005; Kanas, 1998; Francis et al, 2001; Worthington and Higgs, 2004; John et al, 2010), and revealed that there is strong evidence of interdependency between stock market and suggested that shocks and volatility can be transmitted across market
The paper aims to investigate the conditional dependency between GCC stock market and oil price and portfolio management strategies under structural breaks
The results suggest that structural breaks reduce the volatility persistence implying that the conditional volatility is more affected by their own past shocks and own past volatility when structural breaks are ignored
Summary
An abundant literature has investigated the volatility linkage between stock markets (Lieven, 2005; Kanas, 1998; Francis et al, 2001; Worthington and Higgs, 2004; John et al, 2010), and revealed that there is strong evidence of interdependency between stock market and suggested that shocks and volatility can be transmitted across market. A lot of empirical studies have investigated the volatility transmission between oil price and stock market such as those of Jones and Kaul (1996), Park and Ratti (2008), Apergis and Miller (2009). Nandha and Brooks (2009) and Sadorsky (1999, 2012). Their findings show evidence of stock market reactions to oil price changes. Guesmi and Fattoum (2014) examine the interdependence between oil price and stock market for five oil-importing countries (USA, Italy, Germany, Netherland and France) and four oil-exporting countries.
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