Cause & effect relationshipt research paper qta -kashif ahmed saeed

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Issue 023(07)/2012 ISSN: XXXX-XXXX

Quantitative Technique in Analysis using Econometrics

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An investigation of cause and effect relationship between oil and stock prices

Muhammad Imtiaz Subhani 1, Kashif Ahmed Saeed 2, Mohammad Zeeshan3,

Mohammad Obaid4, Yaqoot Zehra 5 Qurat-ul-ain6

1 Iqra University Research Center -IURC, Karachi- Pakistan






Abstract. The objective of this study is to investigate the cause and effect relationship

between oil and stock prices of Pakistan, United states and Kuwait. The present study

examines how rise in price of crude oil supplied for economic consumption in a country

effect to the stock prices similarly how rise in stock prices in a country impact to crude

oil prices and consumption, and what kind of relationship exists between oil and stock

prices. The study is done by taking last 05 years data available for Pakistan, United states

and Kuwait’s economic indicators. Results revealed that rise in oil prices impact in

directly proportion to stock prices of the country.

Key Words: oil prices, stock prices, inflation, Investment.

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1 Introduction

Trend of global business is changing the nature of entire financial system almost all major entities are

interlinked now like commodities, stock and forex all the said markets have now correlation that can be

used smart business geeks in forecasting, now a days stock prices are going sky high as its a general

perception that whenever oil prices increases US$ gets down gradually may be due to negative correlation

Stock and Oil prices are supposed to be the basic parameter in financial trading along with forex rates

which more or less work on the same mechanics,

Our research is based on causes of oil prices and their effects on stock prices and similarly causes of

stock prices and their effects on oil prices for the economy

Individual’s wellbeing is the top most priority for every democratic state. Economy of an individual is as

important as the economy as whole. Since the advent of human history, the individual needs, be it of any

kind, are always be the great interest of human being. A proper source of employment can help to rid-off

from this devastating situation. It is irrefutable that the world is continuously changing. The shift from

the feudal to industrial society and the due importance of finance, individual needs are raised to a visible

extent. In Pakistan, due to enormous rise in population, unemployment and resource constraints, the

individual finances have been badly affected in recent time.

Pakistan with a population of more than 150 million has been on the path of rising GDP growth in

the last couple of years, but since the last fiscal year the situation is not very sound. The continuous rise in

oil prices in the last few years is regarded as one of the contributory factor. Energy sector has a direct

link with the economic development of a country. In line with the rising growth rate of GDP, demand for

energy has also grown rapidly. The magnitude by which economies are hurt as a result of price shock

depends on the share of 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. In the energy mix for the

year 2005-06, oil accounts for 32 percent of the total energy used in Pakistan. Although the intensity with

which oil is used in total energy consumption has declined in the last few years but still it is the second

largest source of energy used after natural gas, which accounts for 39 percent. As far as the energy

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intensity is concerned it has remained almost constant since 1990-91 (i.e., 1 %). Decrease in energy

intensity is considered as the most promising route for reducing vulnerability to oil shocks.

With oil being the second largest source of energy used along with almost a constant rate of its production

Pakistan is heavily dependent on oil imports from Middle East exporters (Saudi Arab playing the lead

role). Almost 82% of the demand for petroleum products in the country is met through imports2. Pakistan

spent about 44 percent of export earnings on oil imports in 2006-07. This percentage was only 27 percent

in 2004-05. Therefore, the international oil price fluctuations have a direct bearing on the macroeconomy

of the country, especially on the oil price GDP relationship. The share of net oil imports in GDP is an

index of the relative importance of the oil price rise to the economy in terms of the potential adjustments

needed to offset it.

The goal in this paper is to shed light on the nature of the impact of oil shocks on the macroeconomic

conditions of a country. This research will analyze the impact of oil price on the output growth of the

country along with the monetary policy function on the presumption that State Bank has pursued inflation

targeting and conducts monetary policy to maintain price stability and output growth. Secondly, this study

will examine the cause and effect relationship between oil prices and stock prices.

2 Monetary policy

Central banks are responsible to implement a country's chosen monetary policy. Establishing what form

of currency needs to be implemented in the country. This is the most basic level of activity by Central

Bank.

A central bank may also use help from another country as their currency either directly (in a currency

union), or indirectly (a currency board). In countries with fiat money, expression "monetary policy" may

mention more closely to the interest-rate targets and other active actions commenced by the monetary

authority.

Goals of Monetary Policy:

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Price Stability: Unanticipated inflation leads to lender losses. Immaterial agreements attempt to

interpretation for inflation. Effort will be successful if monetary policy able to maintain steady

rate of inflation.

High Employment: Frictional unemployment is refers to as the movement of workers between

jobs or workers swapping various jobs. Apart from frictional unemployment, other

unemployment is classified as unintended unemployment. By targeting macroeconomic policy,

reduction in his area can be achieved.

Economic Growth: Economic growth is enhanced by conjecture in scientific developments in

production. Supporting savings supplies funds can be drawn upon for investment.

Interest Rate Stability: Interest Rate Stability refers to as unstable attention and exchange rates

which generate costs to lenders and borrowers. This leads to unexpected changes which cause

impairment, making policy preparation difficult.

The monetary cause includes Money supply and Money demand.

If Money demand (Md) increase, the overall price (P) increase results in lower down the Investment (I)

and higher interest rate (r ) so the aggregate expenditures (AE) will go down causes the lower level of

output/Income.

3 Research Problem

Impact of oil prices to stock index prices and vice versa in economic growth, this study includes the

variable like GDP, Growth, Oil price, stock index and Interest rate.

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Literature Review

Akhtam,Maghyereh (2004) found dynamic linkages between crude oil price shocks and stock market

return in 22 emerging economies.

Oil prices plays a vital role in economy it’s a commodity which is supposed to be the energy engine of

economy. one would expect changes in oil prices to be correlated with changes in stock prices, it is to be

considered that where oil is the basic parameter of economic operation will definitely be affecting

revenue of organizations. Certainly oil prices will be inversely proportional to earnings of public stocks.

Akhtam utilizes general approach to forecast responses of growing oil prices based on current economic

factors.

AROURI ,Mohamed El Hédi (2010) highlighted that there are several passages by which oil prices may

affect stock market or forex prices. The most important of oil price changes as a factor affecting stock

market returns they infected stock returns. These cash-flows are affected by macroeconomic events that

possibly can be influenced by oil shocks. Oil price fluctuations may influence stock market facts and

figures. Past studies and experiences proves this relationship within the framework of using low

frequency (monthly or quarterly) data from oil importing countries. Using weekly data and nonlinear

models, Arouri investigates short-run relationship between oil price shocks and stock markets in the Gulf

Cooperation Council (GCC) countries, previous studies on the impact of oil price changes on GCC stock

markets are too heterogeneous to lead to general repercussions. These findings are confusing as the GCC

countries are strongly oil exporters and share several commonalities in their economic structures. The

conclusions of these studies could be due to the fact that the tests they rely on are not powerful enough to

detect linkages. Arouri contend that there are some confusing signs in the relationship between oil prices

and the economic activity.

4 Research Methodology

Cause-and-effect research methodology was used along with statistics through past data for exploring the

relationship among variables.

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First designed the data gathering method and then using SPSS software for analyzing the data for

reasonable conclusion and testing of hypothesis.

Research Hypothesis

H0: There is no effect of oil prices on stock prices

H1: There is effect of oil prices on stock prices

H2: Oil is not the cause of increase of stock prices

H3: Oil is the cause of increase of stock prices

4.1 Model

Oil_price Consumption Economic_growth Stock_Price

Oil_price Consumption Economic_growth Stock_Price

The Econometric Model would be as follows:

OilPrices = α + β1+Stock_Prices+ET

OR

Stock_Prices = α + β1 + Oil_Prices + ET

Since there were chances that oil prices cans cause stock prices to come down and stock prices may

effect to oil prices to reduce so we use both the test using Granger causality test to find the relation.

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4.2 Sample and Procedures

Last 05 years data of Pakistan, UAE and India

4.3 Data Collection

Data was collected through reliable economic sources by visiting official websites of economic surveys,

State Bank reports, IMF reports and others.

4.4 Hypothesis and Data Analysis

Data analysis is a procedure of scrutinizing, cleaning, transforming, and modeling data with the goal of

underlining useful information, suggesting conclusions, and supporting decision making. Data analysis

has several facets and methods, encompassing assorted techniques under a variety of names, in different

business, science, and social science domains.

The purpose of this paper to investigate cause and effect relationship between oil and stock prices, we

hereby propose below hypothesis for examination

H0: There is no effect of oil prices on stock prices

H1: There is effect of oil prices on stock prices

H2: Oil is not the cause of increase of stock prices

H3: Oil is the cause of increase of stock prices

For this aforesaid hypothesis, first we check the proposed model accuracy and result provide the result

that there is………………………………………….

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We conducted regression test on SPSS. At first, a time series data was collected and transformed the

independent variables into its previous lags. Significant outlier were found and in observation 26, 29,28

and 30 in depended variable which can create distort information so they were transformed.

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It was found that depended variable is only predicting from its current lag and current lag of investment.

There are no significant values determined for other independent variable like interest rate and

GDP/capita.

Inflation predicting from current lag of Investment

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Inflation effects from Investment

Regression was performed to determine whether the data is unbiased or not. The obtained Bi-lateral

Symmetric shaped curve [bell-shaped curve] indicates that the data is unbiased and normally distributed.

The result reveals about the underlying fact that there is BLUE during tradeoff between Inflation and

unemployment.

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Secondly, the result concluded that there is no-correlation exist between inflation and unemployment. It

was also observed by Dublin Watson value which is 2.013.

5 Conclusion

After analyzing the data we conclude our topic according to the above tests and techniques. The findings

of study have led to the result that there is………………………………………

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6 References

Akhtam,Maghyereh (2004).Oil Price Shocks And Emerging Stock Markets International.Journal of Applied

Econometrics and Quantitative Studies. Vol.1-2(2004)

AROURI, Mohamed El Hédi (2010).Oil Price Shocks and Stock Market Returns in Oil-Exporting

Countries.International Journal of Economics and Finance, Vol. 2, No. 5; November 2010

Website Reference

www.sbp.org.pk State Bank of Pakistan - The Central Bank.

www.imf.org IMF -- International Monetary Fund

http://www.opm.gov

http://notesforpakistan.blogspot.com/2009_08_25_archive.html

http://worldwidescience.org/topicpages/m/macroeconomic+risk+factors.html

http://www.sbp.org.pk/

http://www.imf.org/

http://www.opm.gov/

http://notesforpakistan.blogspot.com/2009_08_25_archive.html

http://worldwidescience.org/topicpages/m/macroeconomic+risk+factors.html

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7 Annexure

Propose Model

Inflation= α + β leg Unemployment +β leg Inflation + β leg Interest rate +β leg Investment + β

leg GDP

Year

Inflation

(%)

Unemployment

Rate

Interest

Rate

(%)

Investment

(% of GDP)

Population

(Million)

GDP Per Capita

(Constant Price,

in Rupees)

1980 11.927 3.3 12.5 19.93 82.432 17,322.83

1981 11.949 3.5 12.8 18.49 84.87 17,974.53

1982 5.862 3.8 12.5 18.94 87.38 18,599.54

1983 6.446 3.9 13 18.49 89.89 19,305.73

1984 6.056 3.8 12.8 17.97 92.4 19,732.61

1985 5.564 3.8 13 17.99 94.93 20,664.90

1986 3.467 3.2 12.5 18.53 97.5 21,227.14

1987 4.692 3 12.5 18.97 100.09 22,012.06

1988 8.835 3.1 12 17.85 102.71 23,086.17

1989 7.882 3.1 12 18.79 105.35 23,624.03

1990 9.051 6.2 15 18.81 108.4 23,982.99

1991 12.628 4.7 14 18.81 110.8 24,743.23

1992 4.851 6 15 18.97 114.075 25,915.80

1993 9.825 5.9 14 20.12 117.02 25,581.35

1994 11.272 4.8 17 20.6 119.99 25,880.57

1995 13.022 5 15 19.45 122.985 26,503.39

1996 10.789 5.7 17 18.46 126 27,122.97

1997 11.803 5.8 20 18.85 129.035 26,753.68

1998 7.812 6 18 17.77 132.085 26,802.43

1999 5.736 5.9 16.5 17.76 135.125 27,158.37

2000 3.584 7 13 15.52 137.53 27,820.19

2001 4.41 6 13 17 140.36 27,767.53

2002 2.504 8 10 16.58 143.17 28,092.21

2003 3.102 8.26 8 16.75 146.75 28,738.97

2004 4.568 7.9 7.8 16.57 149.65 30,262.49

2005 9.276 8.3 7.8 19.08 152.53 31,968.95

2006 7.921 6.6 9 22.14 155.37 33,313.93

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Year

Inflation

(%)

Unemployment

Rate

Interest

Rate

(%)

Investment

(% of GDP)

Population

(Million)

GDP Per Capita

(Constant Price,

in Rupees)

2007 7.771 6.5 8.8 22.52 158.17 34,569.04

2008 11.998 5.6 10 22.05 160.97 34,523.78

2009 20.775 7.4 15 18.95 163.774 35,075.51

2010 11.73 6.2 14 16.57 166.578 36,137.73

Cause & effect relationshipt research paper qta -kashif ahmed saeed

Economy & Finance

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