The impact of oil prices on stock prices: market, sector, and firm level analysis

The impact of oil prices on stock prices is of great interest to policymakers, central banks and investors. Despite over 30 years of empirical research, there remains no consensus on the relationship between oil and stock prices. In addition, there has been limited empirical research exploring the impact of oil prices on stock prices at the sector and firm levels. This thesis explores the impact of oil prices on stock prices in oil-importing and oil-exporting countries at the market index, sector indices and firm levels by applying different econometric techniques. First, this study applies the Autoregressive Distributed Lag (ARDL) model to investigate the impact of oil prices on stock prices. Second, the Non-linear Autoregressive Distributed Lag (NARDL) model is applied to test if the effect of increases and decreases in oil prices on stock prices is symmetric or asymmetric. Last, the impact of oil prices on stock prices is examined using the Structural Time Series (STM) model, accounting for the effect of the time series components, namely the trend, cycle and irregular components. The findings of the study are different at the market index, sector indices and firm levels. At the general market index level for oil-importing countries, as expected, there is a negative effect of oil prices on the general index of Japan and China markets. However, surprisingly, the Singaporean index is positively affected by oil prices. For oil-exporting countries, the effect is positive on all countries’ indices, as expected. At the sector level, the impact of oil prices on the general market indices is reflected in most sectors in all countries except Japan, as most sectors show results contrary to the results of the general index of the Japanese market. In this study, STM results differ from expectations, as most stock prices are affected by variables other than oil prices. On the level of general index, findings for the STM show that all indices for all countries show positive results for the impact of oil prices on stock prices. The overall results for sector indices are mixed. Most sector indices in all countries are positively affected by oil prices, whereas other sector indices are not affected. Most stocks at the firm level show significant positive results. Interestingly, STM can help us to understand more how and why the Singaporean stock market index is affected positively by oil prices according to all models applied, when as an oil importing economy, intuition would suggest the opposite. The inconsistency of the Singaporean stock index results with expectations is due to the fact that foreign direct investment increases rapidly throughout the entire period of the study. Another reason for the inconsistency in the results of Singapore with expectations is that revenues from the refinery industry reduced the effect of imported oil, consistent with the fact that Singapore is considered one of the largest oil refinery countries in south Asia. It is worth noting that there is an apparent contradiction in findings between the sector and index levels in the Japanese market. This is an interesting outcome that on investigation is likely due to the use of an advanced derivative market for hedging the risk of fluctuating oil prices, as oil consuming firms might use oil future contracts for a period of time ahead to mitigate spot price and smooth their cash flows, which may leads to reduced visibility over the effect of changing in oil (spot) prices on the cash flows of such firms. Also, the different results at the general and sectors’ indices in Japanese market is due to the high number of listed firms in Japan. The general index is a weighted average of all listed companies in the market, and some sectors would have higher listed firms than others which at this highest level of aggregation can ‘wash out’ or dilute information, therefore, it is more useful when analysing the impact of oil prices on stock market in such an economy to look into this relationship more deeply to the firm level. The findings of this study have significant practical implications for policymakers, investors and managers. Policymakers should consider the impact of the business cycle on oil prices. For example, during times of high oil prices, policymakers in oil-exporting countries should maintain a cash reserve to manage their budget during times of oil price decreases to maintain a constant economic growth rate regardless of the change in oil prices. For investors, the diversification of investments should not be limited to sectors in a particular country, but investment should be diversified across countries to minimise the impact of oil price changes. Finally, it is recommended that firms, which are dependent on oil, use financial derivatives more effectively to reduce the risks of oil price fluctuations.