Stock market and crude oil relationship: A wavelet analysis

shafaai, Shafizal and Masih, Mansur (2013): Stock market and crude oil relationship: A wavelet analysis.

Abstract

Financialisation of crude oil and its frequent inclusion into investment portfolios raise the demand for analysis of crude oil and stock market indices relationship at various time scales. In this paper, the relationships between crude oil and stock markets in three Islamic stock market indices and three non-Islamic indices are examined by using a time-scale decomposition based on the theory of wavelets. This study employs daily closing price data of Brent crude oil index and the six stock market indices. The oil and stock return series are first decomposed into different time components and then their relationships are investigated over different time scales through wavelet’s estimated correlations. We also characterized the crude oil and stock market relationship for different timescales in an attempt to disentangle the possible existence of comovement during the global financial crisis. The results mainly show evidence of significant time scale effects on the behavior of the oil-stock market links, and that investors should consider these effects when diversifying their portfolios of stocks into the oil asset. The paper specifies the investment horizons that should be considered to maximize diversification properties of crude oil. These findings also have important implications for risk management, monetary policies to control oil inflationary pressures and fiscal policy in oil-exporting countries.

• Item Type: MPRA Paper
• Language: English
• Keywords: wavelet analysis, stock markets, crude oil
• Subjects: C - Mathematical and Quantitative Methods > C2 - Single Equation Models ; Single Variables > C22 - Time-Series Models ; Dynamic Quantile Regressions ; Dynamic Treatment Effect Models ; Diffusion Processes; C - Mathematical and Quantitative Methods > C5 - Econometric Modeling > C58 - Financial Econometrics; G - Financial Economics > G1 - General Financial Markets > G15 - International Financial Markets

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