Stock return predictability in China: Power of oil price trend

Abstract

We study the predictability of stock risk premia in the Chinese stock market using oil factors. In contrast to existing findings that oil price changes render little forecasting power for stock returns, we propose an oil price trend factor which strongly predicts excess stock returns in-sample and out-of-sample at both market- and industry-level. Notably, the predictive power of the oil trend factor is unspanned by the existing predictors and macroeconomic risks. We find that the trend factor negatively predicts equity risk premia which is due to the fact that our trend factor represents oil demand-driven force in determining asset return premium.