Oil Price and Composite Risk Exposure within International Capital Asset Pricing Model: A Case of Saudi Arabia and Turkey

Abstract

The aim of this study was to investigate and compare investment opportunities in the financial markets of Saudi Arabia, a net oil-exporting country, and Turkey, a net oil-importing country, in the Middle East. The international capital asset pricing model (ICAPM) was extended by considering local factors proxied by country risk (CR) and oil price risk exposures of the excess returns of Saudi Arabia and Turkey. In this study, we employed the extended ICAPM in a two-state Markov-switching setting for the sample period of January 2005 to December 2018 to explore whether the risk premium is time-varying. The results suggested that systematic risk is time-varying depending on the state of the financial markets and is affected by both global and local factors. Saudi Arabia offered higher excess returns during the high-volatility regime compared to that of the World Index and enjoyed higher returns during the low-risk regime from oil price shocks. Turkey was negatively affected by oil price shocks and was rather sensitive to the country’s risk factor, which varied with both the state of the market and the time factor. These findings will be useful to international investors in diversifying their risks. This study differs from others in estimating the risk premium (beta) by taking into account both the local and global factors and the dynamic nature of systematic risk.