The relationships between petroleum and stock returns: An asymmetric dynamic equi-correlation approach

Abstract

In this paper, we propose an asymmetric dynamic equi-correlation (ADECO) model to investigate the correlations between returns of petroleum futures and stock indices. Our ADECO reveals the in-sample significant asymmetric effect in oil–stock correlations. To evaluate out-of-sample performance, we consider a portfolio with petroleum futures and stocks in which the weights are determined by forecasts of covariance matrix. We find that ADECO provides portfolios with better performances than existing popular DECO, DCC and ADCC models in the minimum-variance framework. Moreover, energy price risk can be better hedged by stocks in oil-exporting countries than stocks in oil-importing countries. Our findings are further demonstrated to be robust to the change of futures maturity.