The importance of oil assets for portfolio optimization: The analysis of firm level stocks

Highlights: • The study investigates the volatility spillover between oil and Pakistani firm stocks. • It attempts to examine the role of oil asset to form an optimal portfolio. • The main contributes is the utilization of individual firm level stocks for spillover and portfolio analysis. • Estimated results report the existence of bidirectional volatility spillover between firm stocks and oil market. • Investors should spend more than fifty percent of total investment to purchase the oil assets. • For financial and investment, and oil and gas firm stocks, investors have to spend more proportion on firm stocks. -- Abstract: This study aimed to analyze the shock transmission and volatility spillover between firm stocks and oil assets by using the BEKK-GARCH model in which a variance and covariance series are used for portfolio optimization. For this purpose, we use the daily data from 107 Pakistani-listed firms covering the period from January 2000 to August 2017. Our overall results confirm the interdependence between firm stocks and oil assets. Additionally, there is strong evidence of volatility spillover from stocks to oil and from oil to stocks. The results from the portfolio optimization show the importance of oil assets in the formation of an optimal portfolio. Moreover, we find that in the case of manufacturing firm stocks, the investors should spend >50% of their total investment to purchase oil assets, while the remaining investment should be used to acquire firm stocks. On the other hand, in the case of investments in oil and gas firm stocks, it is evident that investors can form an optimal portfolio by spending a larger proportion of their investments on firm stocks rather than on oil assets. This research implication can be valuable for portfolio managers and individual investors who are willing to invest in Pakistani stocks.