The Impact of Oil Price on Equity Sector Volatility in Korea

This paper investigates the transmission of volatility and shocks between world oil price and five industry sector indices of the Korean stock market using a bivariate GARCH model. We also analyze the optimal weight and hedge ratio for building optimal portfolios to minimize the exposure to risk from oil price changes. Our empirical results point to the existence of significant shock and volatility spillovers across oil price and sector market indices, but a heterogeneous impact from oil price. For example, the manufacturing industry (MI), construction (CON), and service (SER) sector indices are significantly sensitive to the world crude oil price (WCO). However, both the finance (FIN) and electricity & communication (EC) sector indices are well insulated from oil market volatility changes. In addition, our examination of optimal weights and hedge ratios suggests adding the oil asset into a well-diversified portfolio and hedging the oil price risk effectively. These findings are of practical importance to financial market participants and may be useful in making optimal portfolio allocation decisions and developing cross-market hedging strategies.