Do Oil price Volatility and Selected Macroeconomic Variables Influence Stock Returns Evidence from Nigeria
This study examined the impact oil price volatility and selected macroeconomic indicators on stock return Nigeria for the period of 2000 to 2015 using Exponential Generalized Autoregressive conditional Heteroscedasticity (EGARCH) model for the volatility Error correction model for long and short dynamics. The results are in three folds: First, the results revealed that oil price volatility has a significant negative impact on stock returns in Nigeria. Second, the results also revealed that there were leverage and volatility persistence in the Nigeria Stock Market. Third, the study confirms comovement between oil price shock and equity returns in Nigeria. The study therefore recommends that the government should monitor developments in the world crude oil market with a view to diversifying the economy away from crude oil dependence to minimize the consequences of oil shocks on the stock market and the economy at large. (c) 2019 Elixir All rights reserved. Elixir Fin. Mgmt. 130 (2019) 53197 53204 Finance Management Available online at www.elixirpublishers.com (Elixir International Journal) Paul, Ndubuisi Elixir Fin. Mgmt. 130 (2019) 53197 53204 53198 response to sudden and unpredictable events, called economic shocks. Oil price shock is believed to have implications for stock market performance. The effect will differ from economy to economy depending on whether the economy is an oilexporter or oil importer. In oil exporting economies, a rise in oil prices improves the trade balance and disposable income. This will raise domestic demand and stock price. The reverse becomes the case in an oil importing economy (Abdelaziz et al, 2008) In the last couple of years, the global oil and financial markets have been engulfed in systemic crisis giving research experts and policy makers serious concern. Since 2007, the world has witnessed pronounced collapse in financial institutions, stock market declines, oil prices and exchange rate volatility. Besides, the empirical researches on oil pricestock return nexus have in the past, been the concern of many economists particularly in the developing countries. The results have been mixed and empirical concensus indecisive. As a follow up, this study is aimed at examining the relationship between Oil price shocks and stock return in Nigeria (2000 2015) determine the impact of oil price shocks and macroeconomic aggregates on stock returns, identify if there are leverage effects, asymmetric effects and volatility persistence in the Nigeria stock market. The remainder of this study is structured as follows: Section 2 presents the theoretical; section 3 presents data and methodology of the study. Section 4 presents and discusses the empirical results. Finally, section 5 offers some concluding remarks on the findings. 2.1. Theoretical Framework It is now well established in both empirical and theoretical literature that oil price shocks exert adverse impacts on different macroeconomic indicators through raising production and operational costs. Alternatively, large oil price changes either increases or decreases, i. e. volatility may affect the economy adversely because they delay business investment by raising uncertainty or by inducing costly sectoral resource reallocation. Bernanke (1983) offers theoretical explanation of the uncertainty channel by demonstrating that, when the firms experience increased uncertainty about the future price of oil then it is optimal for them to postpone irreversible investment expenditures. When a firm is confronted with a choice of whether to add energy efficient or energy inefficient capital, increased uncertainty born by oil price volatility raises the option value associated with waiting to invest. As the firm waits for more updated information, it forgoes returns obtained by making an early commitment, but the chances of making the right investment decision increase. Thus, as the level of oil price volatility increases, the option value rises and the incentive to investment declines (Ferderer, 1996) The downward trend in investment incentives ultimately transmits to different sectors of the economy. Hamilton (1988) discusses the sectoral resource allocation channel. In this study by constructing a multi sector model, the author demonstrates that relative price shocks can lead to a reduction in aggregate employment by inducing workers of the adversely affected sectors to remain unemployed while waiting for the conditions to improve in their own sector rather than moving to other positively affected sectors. Lilien (1982) extends Hamilton's work further by showing that aggregate unemployment rises when relative price shocks becomes more variable. According to Hunt, Isard and Laxton (2002) an increase in oil prices can influence the economy through many channels. The first mechanism reflects the transfer of income from oil importing to oil exporting countries, which leads to a decrease in global demand in the oil importing nations. The decrease in demand in the oil importing countries outweighs the increase in the oil exporting countries because of an assumed low propensity to consume in the later. Secondly, given the level of capital stock and assuming that wages are relatively inflexible in the short run, an increase in input costs of production will result in non oil output being affected. Also, since crude oil is a basic input in production, an increase in oil prices leads to an increase in production costs. The third channel is when workers and producers resist a decrease in their real wages and profit margins. This results in upward pressure on labour costs and prices. The fourth channel is through the definition of core inflation. An increase in energy prices raises the consumer price index, leading to calls for action from the central bank. A tight monetary policy has dire consequences on stock returns. According to Odularu (2007) the magnitude of the direct effect of a given price increase depends on the share of the cost of oil in national income, the degree of dependence on imported oil and the ability of end users to reduce their consumption and switch away from oil. It also depends on the extent to which gas prices rise in response to an oil price increase, the gas intensity of the economy and the impact of higher .prices on other forms of energy that compete with or, in the case of electricity, are generated from oil and gas. Naturally, the bigger the oil price increase and the longer higher prices are sustained, the bigger the macroeconomic impact. In most of oil exporting countries, like Nigeria, government which is considerably large in comparison with small private sector, directly receives the oil revenue. Spending this revenue, government's behaviour becomes the most important characteristic of the economy. In other words, the funds needed for government's expenditure come from oil revenue. So, fiscal and monetary policies depend upon oil price (Riman et al, 2013) Since any rise or fall in the oil price is not permanent oil revenue variation injects instability to the economy. In this situation, so/called resource curse occurs. When oil price rises, the government has more money to spend. In other words, according to Kilian (2005) when the country's terms of trade are favourable, oil dependent government's spending can be easily financed through oil revenue. Though, this revenue can be used to finance developmental projects to increase the welfare, but inefficient public spending and fiscal expansion lead to wastes. This destructive strategy, over time, makes the economy more vulnerable to oil price volatility particularly in the presence of capital market imperfections (Anashasy, Bradley and Joutz, 2005) Oil price changes also influence foreign exchange markets and generate stock exchange panics, higher interest rate, produce inflation and eventually lead to monetary and financial instability. According to Jimenez Rodriguez and Sanchez (2004) some of these indirect effects may involve economic policy reactions. For instance, authors like Bohi (1991) and Bernanke, Gertier and Watson (1997) argue that economic downturns observed after oil price shocks are caused by a combination of direct impacts of the shocks themselves and the monetary responses to them. Mckillop (2004) adds that such could lead to higher interest rates, inflation and even a plunge into recession. Paul, Ndubuisi Elixir Fin. Mgmt. 130 (2019) 53197 53204 53199 2.2. Empirical Literature Studies on impact of oilprice, macroeconomic variables on stock return are scanty in Nigeria. Notable studies in Nigeria have been grouped and reviewed under the following sub headings based on the objectives of the study. Sadorsky (2001) in study conducted with respect to Canada, shows a significant and positive relationship between oil and gas equity index and the price of crude oil. The author indicates a positive relationship between the return on the index and the return on the stock market as a whole. Finally a negative association is found between the stock market index value and both the premium on 3 month vs. 1 month Government debt and the US/Canadian Dollar exchange rate. Papaetrou (2001) on the other hand tests the dynamic linkage between crude oil price and employment in Greece using industrial production and industrial employment as alternative measures of economic activity. His study is modelled in a cointegrated VAR framework and extends out by looking at the generalized variance decomposition and impulse response functions, which is very encouraging as most studies have not gone beyond cointegration and error corrections modeling. Omojolaibi (2013) examines the effects of crude oil price changes on stock returns in oil dependent economy Nigeria. A small open economy Structural Vector Autoregressive (SVAR) technique was employed to study the macroeconomic dynamics of domestic price level, stock returns, money supply and oil price in Nigeria. The sample c