The effect of oil implied volatility and geopolitical risk on GCC stock sectors under various market conditions

Abstract

The importance of crude oil volatility and geopolitical risk for stock pricing is well known in both developed and emerging economies, but is relatively understudied in major oil-exporting countries at the sectoral level of stock indices and under various market conditions. Using daily data on eight Gulf Cooperation Council (GCC) stock sector indices over the period February 2010–30 June 2022, we capture the effect of two global risk factors, namely oil implied volatility and geopolitical risk, on stock returns and volatility while accounting for bull/bear markets and low/high volatility regimes. The analysis indicates the following results. Firstly, the effect of oil implied volatility is stronger than that of geopolitical risk, notably for Consumer Discretionary and Staples. Secondly, the effect on both returns and volatility is generally positive during bull markets, but it is stronger for volatility; the response of the returns of Energy, Materials, Industrials, and Financials is negative in bear markets and positive during bull markets. Thirdly, the effect of oil implied volatility on stock sector volatility is slightly higher during the COVID-19 outbreak for some cases and is prominent during bull markets. Our findings matter for the predictability of GCC stock sector returns and volatility and for the design of hedging strategies under various market states.