Oil beta uncertainty and global stock returns

Abstract

This paper documents an economically and statistically significant positive premium for oil beta uncertainty in the cross-section of global equity returns. Using a battery of market and portfolio level tests, we show that oil beta uncertainty, measured by the total range spanned by the 95% confidence interval for estimated oil betas, carries a significant risk premium as high as 9.72% on an annual basis, even after controlling for global systematic risk factors. While most developed stock markets including Australia, Canada, Switzerland, the US and the UK consistently place in the low oil beta uncertainty portfolio, emerging stock markets including Turkey, China, Egypt, Pakistan and Vietnam are found to be consistently exposed to higher oil beta uncertainty. We show that the risk premium associated with oil beta uncertainty cannot be explained by a stock market's exposure to market beta, oil beta or idiosyncratic volatility and is stronger during high volatility periods, bullish market states as well as periods of favorable economic conditions. Further analysis suggests that aggregate oil beta uncertainty also captures significant predictive information regarding future world market excess returns, particularly at the medium and longer forecast horizons. We argue that oil beta uncertainty serves as a proxy for disagreement (or ambiguity) on the sensitivity of stock markets to global economic conditions, captured by oil market exposures, which in turn contributes to a risk premium associated with oil beta uncertainty. The findings present a new, behavioral channel in which oil market uncertainty drives the cross-section of global stock market returns.