The skewness of oil price returns and equity premium predictability

Highlights: • We show the skewness of oil price returns can predict stock market returns. • Out-of-sample results indicate the skewness of oil price returns can obtain superior prediction performance • An investor can realize remarkable economic gains using the skewness of oil price returns. • The prediction performance of the skewness of oil price returns is robust to a series of extension test. We show that the three-order moment of oil price returns can predict the aggregate stock market returns. Empirical results indicate the stock market returns forecasts generated by the skewness of oil price returns are statistically and economically significant for out-of-sample performance. We add the skewness of oil price returns as an additional predictor into the univariate macro model, and obtain greater forecast gains. When using multivariate information method, this prediction improvement also exists. Strong evidence demonstrates that the forecasting power is higher in recession. In addition, our finding is robust when considering alternative aversion coefficient and transaction cost.