THE ASYMMETRICAL EFFECT OF OIL PRICES ON FIRM RETURNS: EVIDENCE FROM THE U.S. OIL AND GAS INDUSTRY

Abstract

The price of oil is one of the most significant risk factors for stock returns in the U.S. oil and gas industry. Yet the degree to which changes in oil price affect returns varies by each firm depending on its firm specific characteristics, as well as by the direction of the change in oil price itself. In this paper, I identify certain firm characteristics that determine an oil and gas stock’s sensitivity to oil price, including market value of equity and financial leverage. I also demonstrate that oil price changes impact returns differently depending on whether the change is positive or negative. I attempt to explain this asymmetry by investigating whether firm characteristics affect oil price sensitivity disproportionately depending on the direction of oil price change. While I find evidence that firm characteristics are indeed asymmetrical determinants of oil price sensitivity, I also find the asymmetrical effect of oil price itself on returns to remain yet existent, leaving investor irrationality as a possible explanation for the phenomenon.