A Threshold Effect of Covid-19 Risk on Oil Price Returns

Examining U.S. data, we investigate how the Covid-19 pandemic influences oil price returns in an asset pricing framework. Unlike previous studies, we consider a threshold model to allow for the possibility that Covid-19 risk may not play a role until it reaches a certain level. Our findings show that oil returns significantly decline with the daily number of Covid-19 deaths, but only if the daily death number exceeds 2,100. In addition, a more severe Covid-19 situation can substantially increase the exposure of oil returns to various systematic risk factors. We discuss the economic reasons and implications of these results.