1. Introduction1.1. BackgroundThe l

1. Introduction
1.1. Background
The literature on the effect of the oil price on firm returns is large and
growing; for an influential list of studies, see Chen et al. (1986),
Driesprong et al. (2008), Jones and Kaul (1996), and Narayan and
Sharma (2011). There is another branch of this literature which focuses
not on firmreturns but on market and industry returns (see Cologni and
Manera, 2008; Nandha and Faff, 2008; Park and Ratti, 2008; among
others). A feature of both these groups of studies is that the oil price
has a statistically significant effect on returns. We take this literature
forward in a novel way. Despite the plethora of studies investigating
the effects of the oil price on returns, two questions remain. First, does
an increase in the oil price contribute to stock return volatility? Second,
does a statistically significant relationship between oil price and stock
return volatility translate to economic significance? The literature alluded
to above has generally ignored exploring the economic significance
of the oil price–stock returns relationship.
We attempt to answer these questions for 560 firms listed on the
NYSE, using time series daily data for the period 2000 to 2008. That
the oil price affects firm returns implies that it should affect firm return
volatility. Marquering and Verbeek (2004), for instance, argue that
factors that impact the first moment of returns should also impact the
second moment. Moreover, Christoffersen and Diebold (2000) argue
that if volatility fluctuates in a forecastable way, volatility forecasts are
useful for riskmanagement. Given the importance of firm return volatility
forecasts in risk management, what remains of interest, and has not