Impacts of oil on the stock markets

Impacts of oil on the stock markets

CHAPTER ONE

Introduction

The purpose of this paper is to examine the impacts of oil on the stock markets. Oil affects the stock market and attacks both investors and researches both from theoretical and empirical perspectives. Oil is a significant fuel source globally, and it accounts for almost 39.9 percent of the ecosphere consumption. Machinery to plastics uses oil or oil by-products to move. Apart from increasing concern on other renewable sources of energy, oil remains essential and unaffected. The impacts of oil on corporate liquidity and earning indicate its importance on the world’s economy, thus increasing both theoretically and empirically on the stock market. Previously, the relationship between oil prices and the stock market had an inverse correlation. Some economists proposed that oil prices affect the stock market due to an increased quantity of money, independent of oil prices. When there is increased consumption, prices might rise and fall in price when there is increased oil production. Decreased fuel prices result in cheaper airline tickets, thus lower transport costs. Increased oil production means lower oil prices hence affecting the company and the domestic oil workers.

An increase in oil prices usually increases inflation and lower the predicted economic growth rate. Increased inflation is a long-term effect of higher wages due to the increased cost of goods and services. The increased cost might put down the profit margin on the stock market, thus raise in the assets contained in the company with increased inflation.  A decrease in the economic growth rate, in turn, decreases the company expectation earning and finally leading to dampening effects of stock prices. However, the profit margin can be compressed due to the increased input of the company associated with increased oil prices. When the oil prices are increased, investors might be uncertain about the corporate earnings, which can lead to a greater risk of bonuses, thus putting more downward pressure on the stock prices.

Rising oil prices can reduce consumer’s demand for other goods. It means that the consumer will have less money to buy new commodities such as televisions and phones. Decreased oil prices can increase the consumer demand for other goods hence increasing the company revenue. Rising the oil prices can cause the profit of the oil companies to increase, reduce the profit margin, and cause the cost of production can be lower.

Research Problem

Oil prices affect the stock market through their effects on the economic rate on the monetary value, inflation, and company income. An increase in oil prices has affected the economic rate negatively. Increase inflation has reduced the customers’ demand for other commodities hence lowering the standard of living.

Oil importers have deteriorated and improved foreign currency for exporters. Increased oil prices raised the cost of inflation because the transport costs increased and thus higher cost of other goods. The cost-push inflation, caused by increased oil prices, has presented a dilemma to the policymakers.

The short-term effects of increased oil prices have made consumers shift consumption and used alternatives sources of fuel, such as using only petrol for running a car and the long-term effects of buying hydrogen-powered cars.

Research Objectives

General objectives

Research on the impacts of oil prices on the stock markets using the theoretical and empirical test. Investigate the relationship between the oil prices and Macro-economic variables.

Specific objectives

firstly, determine the effect of increased oil prices on the stock market.

Secondly, find out how the increase and decrease in oil prices affect the inflation rate.

Thirdly, establish a relationship between the inflation rate and increased oil prices.

Fourthly, give a clear view of the history of oil prices, recent global oil scenario, and future energy demand and supply.

Research Question

In this study, the researcher seeks answers to the following questions:

What is the current price of oil?

How do oil prices relate to the stock market?

How does the rise in oil prices affect the economy?

Increase or decrease in oil prices impact on the macroeconomic variables?

How do oil prices lead to inflation?

Hypothesis

HO1: There is a mutual relationship between oil prices and the stock market.

HO2: the empirical test, there is no common relationship between oil prices and macro-economic variables.

HO3: increase or decrease oil prices affect the rate of the economy positively or negatively.

Research Significance

It is important to study the impacts of oil prices on the stock market has it affects the countries GDP growth rate. An increase in oil prices can impact the economy depending on a variety of factors, such as infrastructure and level of economic progress.

An increase in oil prices negatively affects the economy, and there is a need to understand those effects. It is good to understand the consequences of high oil prices to adopt appropriate monetary value that will minimize the effects of high oil prices on the high economic rate. Knowing the oil price history can help evaluate the oil price policy and help the country make an effective suggestion to improve the same.

Study setting

The study is intended to cover the geographical area of Bahraini. But the researcher is required to collect quantitative and qualitative information from the World Bank. The study of past, present, and future oil prices shows how the monetary value has been changing. Find out the impacts of oil prices on the stock market, and recommend the appropriate solution. Study the oil prices since 2010 and construct and cost the inflation curve.

Research Terminologies

Gross domestic product (GDP) is the monetary value of finished goods and services made in the country for a specific period and used to estimate the country’s economic and growth rate.

Inflation is the rate in which the prices of goods and services increase in the economy within a specific time.

Revenue is the income a business earns after selling goods and services to customers.

Import is goods and services produced in a country and bought by other countries. That is the purchase of goods in the buyer’s domestic market, while Export sells goods and services to a foreign country.

Correlation is a statistical method that shows how strongly pair of variables relate. It is used in data analysis.

Empirical is research-based that derives knowledge from experience on observed and measured phenomena.

Methodology

 This chapter outlined the methodology and the empirical test performed in the analysis. The selection of empirical model was based on previous research on oil prices on the stock market. All regressions have been conducted using the software package EViews.

The method relationship between oil prices on the stock markets was examined using a vector autoregressive (VAR) model containing five variables to assess the different effects. We selected the linear specification of the world real oil price and included other variables related to the stock market. These variables are the long interest term and short-term interest rates and economic rate.

Unit Root Test

The first step of statistical analysis was examining stationarity in the variables. Y_et, this series was based on the stationary distribution of Variable, which independent of time. The mean and variance were constant over time. Non -stationarity in the variables were as a result of a unit root in the time sequence. Regression on non-stationary time sequences might be false, due to a non-reliable t-test.

Cointegration test

A cointegration test was conducted on variables containing a unit root.

When there is any linear combination, two non-stationary time sequences become cointegrated. The Cointegration test reveals that r is the cointegration vector.  When test statistics are compared to the critical value and become greater than the critical value, the null hypothesis of the r=0 is then rejected. If the test statics become lower than the critical value, the null hypothesis of the r vector is accepted.

Vector autoregressive model

We chose empirical research on the impacts of oil prices on the stock markets as unrestricted vector autoregressive models. In this mode, it was easy to capture the dynamic relationship between oil prices and the effects of the stock market. A VAR model contains equations that express variable as a linear function and the lagged value of other variables in the system. VAR model p represents the lag variable, including the k variable.

Lag Length Selection

When using unrestricted VAR, all the variables in the lags number are required to be the same. Thus, the optimal lag length is calculated by using information criteria. These criteria include two factors the residual sum of square (RSS) and penalty term of using extra parameters.in this method, and we will apply the information criterion and choose the appropriate number of lags for the model.

Impulse response

This tool examines the responsiveness of endogenous variables in the VAR model to shock in each Variable. VAR is demonstrated over time using the unit shock applied to the error and the effects. A shock i-th variable affects the i-th Variable directly and can be transmitted to other endogenous variables through the VAR model. Impulse response, for instance, n, can result from a shock to each of the n, variables in the VAR system. It gives the function and the graph the total of n x, showing that the graphs are impulse functions.

Variance Decomposition

Variance decomposition was another test that was used to test the VAR model. According to Brooks (2018, p.300), variance decomposition can affect the movement of endogenous variables caused by shocks of the other Variable. The shocking series explains the larger fraction of the forecast errors in the variance of the VAR series.

Ordering

Ordering method was used to estimate the VAR models ordering that the variables have en effect on the impulse response and also, variance decomposition. Ordering variables must be based on economic theory. (Brooks,2018p.314).

Data collection

Data on the oil prices were collected in the world bank and organization for economic cooperation and development (OECD) from the database. The main aim of the thesis was the impacts of oil prices on the stock market, used questionnaires to know how the customers are affected by the rise in oil prices.

Data statistics

Table 1 below summarizes statistics for the world real oil prices, dlog(op) (op)

Mean       0.5581

Maximum      20.26

Minimum      -22.77

Std. Dev.       7.538

Skewness      -0.459

Kurtosis      3.792

No. of obS        246

Notes: Mean, maximum, minimum, and std. dev is in percent

From the data collected, the statistics show that oil price changes affect the mean positively; this indicates that an increase in oil price is more prone to the stock market.

The cost of oil has been increasing, decreasing the economy and affecting the consumer demand for goods hence increasing the inflation rate.

Stocks that go up when the oil prices go down.

When the prices of oil increase, there is an increase in demand in other sectors because the consumer prefers alternative sources.