Volatility spillovers between oil and stock market returns in G7 countries: A VARDCC-GARCH model

Abstract

The oil prices declined from a peak of $115 per barrel to under $35 between June 2014 and February 2016. This decline was due to the decision of the Organization of Petroleum Exporting Countries (OPEC) to maintain an oversupply in November 2014, despite declining demand for crude oil and the United States’ growing shale capacity. We examine whether the decline in oil prices can be attributed to the impact of OPEC oversupply on stock market volatility in the G7 countries. We apply a vector autoregressive model in a multivariate generalized autoregressive setting with the dynamic conditional correlation. The results indicate bilateral volatility spillovers since the beginning of the 2014 oversupply period. Dynamic correlations between oil and stock prices started to increase but, in the middle of 2016, started to decrease again after rebalancing. Oil price decreases seemed to increase the conditional correlations between oil and the stock market in the USA, Europe, Japan, and Canada as investors responded positively to oil price declines. Analyzing hedge ratios calculated from the conditional correlations and portfolios we establish, we find that optimal oil-stock portfolios outperforms index investment.