Essays on the Linkage Between Oil Price and Stock Market Returns

Download or read book Essays on the Linkage Between Oil Price and Stock Market Returns written by Mohan Singh Nandha and published by . This book was released on 2009 with total page 408 pages. Available in PDF, EPUB and Kindle. Book excerpt: Oil is a special type of commodity which plays a significant role in modem economic activity. The influence of the oil (crude oil) price on stock markets is often recognised and reported in the financial press. This thesis examines the role of the oil price in explaining stock market returns. By applying different methodologies and datasets, empirical evidence has been gathered on various dimensions of the issue which include short-run and long-run comparisons, cross-country analysis, sector¬focused analysis, cross-sector comparisons and a global view. Four of the studies included in this thesis use multi-country data and four are based on multi-sector equity data. Overall, all countries and all sectors (subject to data availability) have been covered in one or another study. Results of a study focused on India, Pakistan and Sri Lanka (all net oil importers) indicate several industries to be significantly sensitive to the oil price factor in the long-run, whereas very little sensitivity to oil price is detected in the short run. Perhaps, this might be an indication that because of the regulated nature of fuel pricing in all three countries, it could take time before the price change is aJlowed to impact consumers and firms. Cross country and cross sector comparisons suggest that the oil price impact on stock market returns is inconsistent across countries and varies across sectors. These differences might be a consequence of regulatory and structural disparities across countries. Across sector variations may result from differing sector abilities to pass on higher fuel costs to customers. In addition, intensity of a sector to the use of oil and its by-products would also make a difference. Two of the studies are sector focused, covering the 'oil and gas' and 'transportation' sectors. These sectors are special in a sense that oil is the main output for the first sector and a major cost component for the second sector. Evidence from the U.S. market suggests that oil and gas stock returns are positively sensitive to the oil price, but an oil risk premium is not priced in the returns. This finding could suggest that oil price risk is diversifiable or can be effectively hedged by investors in oil and gas stocks. The transport sector focused study provides a global perspective in a sense that all countries are covered. This study is supportive of oil playing a jointly significant role in the transport sector returns for the Developed, Europe and 07 country groups. Finally, a study based on global sector indices is indicative of a negative impact on all sector returns except the mining, and oil and gas sectors. These results are consistent with the theoretical logic that a rise in the oil price is likely to reduce the profitability of firms which use oil and/or by-products of oil. This type of agreement between the theory and empirical evidence may also suggest that globally diversified and sector specific portfolios are the best choice for analysing the oil price sensitivity of stock market returns. Overall, oil appears to have some connectivity with the pricing of equities but various types of cross country and cross sector disparities make the pricing dynamics complex and difficult to quantify in exact terms.