Oil price uncertainty as a predictor of stock market volatility

In this paper we empirically examine the impact of oil price uncertainty shocks on US stock market volatility. We define the oil price uncertainty shock as the unanticipated component of oil price fluctuations. We find that our oil price uncertainty factor is the most significant predictor of stock market volatility when compared with various observable oil price and volatility measures commonly used in the literature. Moreover, we find that oil price uncertainty is a common volatility forecasting factor of S&P500 constituents, and it outperforms lagged stock market volatility and the VIX when forecasting volatility for medium and long-term forecasting horizons. Interestingly, when forecasting the volatility of S&P500 constituents, we find that the highest predictive power of oil price uncertainty is for the stocks which belong to the financial sector. Overall, our findings show that financial stability is significantly damaged when the degree of oil price unpredictability rises, while it is relatively immune to observable fluctuations in the oil market.