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Oil Price Risk and Financial Contagion

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In this paper we test for the existence of equity market contagion, originating from oil price fluctuations, to regional and domestic stock markets. The data are collected over the period from April 1993 to April 2015. We apply an empirical multifactor asset pricing model with three-factor setting to capture the unexpected return and disentangle simple correlation due to fundamentals and contagion. We investigate four regions: the European Monetary Union (EMU), Asia-Pacific (AP), the Non-European Monetary Union (NEMU) and North America (NA). We define contagion as the excess correlation that is not explained by fundamental factors. Oil price risk is shown to be a factor as important as contagion. In addition, oil price fluctuations amplify contagion in the context of regional markets strongly interlinked with the USA.

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Energy Specializations: Petroleum – Markets and Prices for Crude Oil and Products; Energy Investment and Finance – Trading Strategies and Financial Instruments; Energy Investment and Finance – Public and Private Risks, Risk Management

JEL Codes: Q41: Energy: Demand and Supply; Prices, G12: Asset Pricing; Trading Volume; Bond Interest Rates, Q40: Energy: General, E44: Financial Markets and the Macroeconomy, G11: Portfolio Choice; Investment Decisions, Q35: Hydrocarbon Resources, Q31: Nonrenewable Resources and Conservation: Demand and Supply; Prices

Keywords: Global financial crisis, financial contagion, Oil price risk, ICAPM, GJR-DCC-GARCH

DOI: 10.5547/01956574.39.SI2.kgue

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Published in Volume 39, Special Issue 2 of the bi-monthly journal of the IAEE's Energy Economics Education Foundation.


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