Oil uncertainty and firms' risk-taking

Abstract

Motivated by the limited evidence for a relationship between oil uncertainty and firms' risk-taking in China, we investigate how oil uncertainty (as proxied by the oil volatility risk premium) impacts firms' risk-taking and explain the mechanism. To highlight firms' expectations, growth opportunities, and ability to process new information, we use three proxies for firms' risk-taking (the implied cost of capital, the idiosyncratic volatility and the idiosyncratic skewness). Our empirical results show that oil uncertainty increases firms' risk-taking through the channel of risk compensation or real options related to firms' growth opportunities rather than risk-aversion. Oil uncertainty has a positive effect on firms' risk-taking proxied by the implied cost of capital and the idiosyncratic volatility but a negative effect on firms' risk-taking proxied by the idiosyncratic skewness related to contract options. Various variables involved in ownership, operating leverage and industrial conditions interact with oil uncertainty to affect firms' risk-taking through different channels. Our findings contribute to a greater understanding of the uncertainty in crude oil markets and firms' risk-taking behavior.