Impact of Oil Price Shock and Its Effects on Stock Returns in Nigeria.
CHAPTER ONE
1.1 BACKGROUND OF THE STUDY
Oil price shocks poses a great challenge to policymakers and economist across countries, in terms of the increasing spate of fluctuations in oil prices, following the two oil price shocks in 1973 and 1979, which prompted a decline in the economic activities of major exporting countries. As a result several attentions have been made to study the relationship between oil price shocks, stock returns and other macroeconomic variables. Sadorsky (1996) explained that high oil prices reduced output and increased inflation in 1970’s and early 1980’s falling oil prices boosted output and lowered inflation particularly, in the U.S in the mid to late 1980’s.
Oil price shocks and aggregate stock returns are important macroeconomic variable in the open economy, because high oil prices tend to show how vibrant a stock market is because it helps to attract capital inflows from foreign investors, which in turn increases the demand for its currency. On the other hand, falling oil prices allow foreign investors try sells their stocks to avoid further losses and allow their money into foreign currency allowing it to move out of the country and consequently local currency depreciates. By implication, stock prices will definitely affect exchange rate and money demand because investor’s wealth and liquidity demand could be a function of the performance of the stock market.
Researches shows that Oil prices enhance series of change in the exchange rate and in turn affect the competitiveness of firms as variations in the exchange rate affect the value of the earnings as well as the cost of funds because many companies borrow in foreign currency to finance their operation and hence its stock price. Therefore an appreciation of the local currency, for example, makes exporting goods unattractive and leads to a decrease in foreign demand and hence revenue for the firms and its values would fall which definitely affect stock price and return.
1.1 BACKGROUND OF THE STUDY
Oil price shocks poses a great challenge to policymakers and economist across countries, in terms of the increasing spate of fluctuations in oil prices, following the two oil price shocks in 1973 and 1979, which prompted a decline in the economic activities of major exporting countries. As a result several attentions have been made to study the relationship between oil price shocks, stock returns and other macroeconomic variables. Sadorsky (1996) explained that high oil prices reduced output and increased inflation in 1970’s and early 1980’s falling oil prices boosted output and lowered inflation particularly, in the U.S in the mid to late 1980’s.
Oil price shocks and aggregate stock returns are important macroeconomic variable in the open economy, because high oil prices tend to show how vibrant a stock market is because it helps to attract capital inflows from foreign investors, which in turn increases the demand for its currency. On the other hand, falling oil prices allow foreign investors try sells their stocks to avoid further losses and allow their money into foreign currency allowing it to move out of the country and consequently local currency depreciates. By implication, stock prices will definitely affect exchange rate and money demand because investor’s wealth and liquidity demand could be a function of the performance of the stock market.
Researches shows that Oil prices enhance series of change in the exchange rate and in turn affect the competitiveness of firms as variations in the exchange rate affect the value of the earnings as well as the cost of funds because many companies borrow in foreign currency to finance their operation and hence its stock price. Therefore an appreciation of the local currency, for example, makes exporting goods unattractive and leads to a decrease in foreign demand and hence revenue for the firms and its values would fall which definitely affect stock price and return.
References: Adebiyi, M.A; Adenuga, O.A; Abeng, M.O and Omanukue, P.N (2008) “Oil price shocks, Exchange rate and Stock market Behaviour”. Empirical evidence from Nigeria. Abdelaziz, M: G Aleisa, E.A: and S. Dibooglu (2002) “Sources of Real Exchange Rate Movements in Saudi Arabia” Journal of Economics and Finance Volume 26, Number 1,pg 101-110. Ayadi, O.F,(2005). ‘Oil Price Flunctuations and the Nigerian Economy’ OPEC Review: 199-217. Ashar, T.A; G. Arabian, and R. Zomorrodian, (2008) “Oil Price Shocks and the U.S Stock Market Paper prepared for the IABR &TLC Conference Proceedings, San Juan, Pueto Rico,USA. Basher , S.A and P,(2006). “Oil price risk and emerging stock markets.” Global Finance Journal,17, P:224-251. Brown, S. P., & Y¨ucel, M. K. (2002). Energy Prices and Aggregate Economic Activity: An Interpretative Survey Bernanke, B. S., Gertler, M., Watson, M., Sims, C. A., & Friedman, B. M. (1997). Systematic Monetary Policy and the Effects of Oil Price Shocks. Brookings Papers on Economic Activity, 1997 , 91-157. Bjornland H.C. (2008). “Monetary Policy and Exchange Rate Interactions in a Small Open Economy,” Scandanavian journal of economics, Blackwell Publishing, vol, 110(1), pages 197-221. Cavallo, M and T. Wu (2006) “Measuring Oil Price Shocks Using Market Based Information” Federal Reserve Bank of San Francisco Working Paper Series,WP 28. Chaudhuri, K., Daniel, B.C., 1998. Long-run equilibrium real exchange rates and oil prices. Economics Letters 58, 231-238. Cheung, Yin-Wong, Lilian (2003), “International evidence on the stock market and aggregate economic activity” Journal of Empirical Finance, 5(3) 281-296 Cheung, Y Cologni, A., & Manera, M. (2008). Oil prices, Inflation and Interest Rates in a Structural Cointegrated VAR Model for the G-7 Countries. Energy Economics, 30 , 856–888. Cong, R.G, Y.M, Wei, J.L Jiao, and Y. Fan (2008). “Relationships between oil price shocks and stock market: An empirical anaylsis from China.” Energy Policy, Vol 36 issue 9. Darby, M.R (1982) “The Price of Oil and World Inflation and Recession,”American Economic Review 72: 738-751. Driesponga, G; B Edelstein, P., & Kilian, L. (2007). The Response of Business Fixed Investment to Changes in Energy Prices: A Test of Some Hypotheses about the Transmission of Energy Price Shocks. The B.E. Journal of Macroeconomics, Article 35. Gregorio, J. D., Landerretche, O., & Neilson, C. (2007). Another Pass-Through Bites the Dust? Oil Prices and Inflation (Working Paper No Frederic s. Mishkin (1998) The Economics of Money, Banking and Financial Market. Faff, R. W., & Brailsford, T. J. (1999). Oil Price Risk and the Australian Stock Market. Journal of Energy Finance and Development, 4 , 69–87. Huang, B.N., Hwang, M.J..,Peng, H.P., (2005) The asymmetry of the impact of oil price shocks on economic activites; an application of the multivariate threshold model Lee.K., and S.Ni (2002). “On the Dynamic Effects of Oil price shocks; A study using industry level data,” journal of monetary economics 49: 823-852 Hamilton, J Hamilton, J. D. (1996). This is What Happened to the Oil Price – Macroeconomy Relationship.Journal of Monetary Economics, 38 , 215-220. Hamilton, J. D. (2003b). What is an Oil Shock? Journal of Econometrics, 113 , 363-398. Hamilton, J. D. & Herrera, A. M. (2004). Oil Shocks and Aggregate Macroeconomic Behavior: The Role of Monetary Policy Hooker, M. A. (1996b). What Happened to the Oil Price-Macroeconomy Relationship? Journal of Monetary Economics, 38 , 195-213. Hooker, M. A. (1999). Oil and the Macroeconomy Revisited (FEDS Working Paper No. Huang, B.-N., Hwang, M., & Peng, H.-P. (2005). The Asymmetry of the Impact of Oil Price Shocks on Economic Activities: An Application of the Multivariate Threshold Huang, R. D., Masulis, R. W., & Stoll, H. R. (1996). Energy Shocks and Financial Markets Hunt, B. (2006). Oil Price Shocks and the U.S. Stagflation of the 1970s: Some Insights from GEM Hunt, B., lsard, P., & Laxton, D. (2001). The Macroeconomic Effects of Higher Oil Prices (Working Paper No Iwayemi, A. and Fowowe, B. (2009) “Oil and the Macroeconomy” Empirical Evidence from Oil Exporting Countries. Jones,C.M., and G. Kaul (1996) ‘Oil and the Stock market, journal of finance 51 : 463-491 Koranchelian, T Kilian, L. (2008a). A Comparison of the Effects of Exogenous Oil Supply Shocks on Output and Inflation in the G7 Countries. Journal of the European Economic Association,6 , 78-121. Kilian, L. (2008b). The Economic Effects of Energy Price Shocks. Journal of Economic Literature, 46 , 871-909. Kilian, L. (2008c). Not All Price Shocks Are Alike: Disentangling Demand and Supply Shocks in the Crude Oil Market Mork, K.A. (1989) “Oil and the Macroeconomy when Prices Go Up and Down; An Extension of Hamilton’s Results”, Journal of Political Economy 97; 740-744 Mork, K.A Nandha, M., & Faff, R. (2008). Does Oil Move Equity Prices? A Global View. Energy Economics, 30 , 986–997 Olomola , P.A and Adejumo A.V (2006) “ Oil Price Shocks and Macroconomic activities in Nigeria. Ozturk I. M, Feridun and H. Kalyoncu (2008) “Do Oil price affect USD/YTL. Exchange Rate: Evidence from Turkey. Papapetrou, E Park, J.W, and R.A Ratti (2007) “Oil price shocks and the Stock Markets in the U.S.and 13 European Countries” Energy Economics,30,p: 2587-2608. Pierce J.L and J.J Enzler (1974) The Effects of External Inflationary Shocks.” Brooklings Papers on Economic Activity. Sakellaris, P Sanchez, M. (2008). Oil Shocks and Endogenous Markups (Working Paper No. 860). Rodriguez, Rebecca and Marcelo Sanchez (2005), “Oil price shocks and Real GDP Growth: Empirical Evidence for some OECD Countries”. Applied Economics, 37(2):201-218. Raguindin, C.E and R.G. Reyes (2005): The Effects of Oil Price Shocks on the Philippine Economy: A VAR Approach, Working Paper, University of Philippines School of Economics. Sadorsky, P.(1999). “Oil price shocks and Stock Market Activity.” Energy Economics, volume 21, issue 5. Sadorsky, P. (2000). The Empirical Relationship Between Energy Futures Prices and Exchange Rates Sadorsky, P. (2001). Risk Factors in Stock Returns of Canadian Oil and Gas Companies. Energy Economics, 23 , 17-28. Sadorsky, P. (2002). Time-Varying Risk Premiums in Petroleum Futures Prices. Energy Economics, 24 , 539-556. Sadorsky, P. (2003). The macroeconomic determinants of technology stock price volatility. Review of Financial Economics, 12 , 191-205. Sadorsky, P. (2008). Assessing the Impact of Oil Prices on Firms of Different Sizes: Its Tough Being in the Middle Symth,D.J.(1993) “Energy prices and Aggregate production function” Energy economics. Wei, C. (2003). Energy, the Stock Market, and the Putty-Clay Investment Model. American Economic Review, 93 , 311-323.