Oil price shocks and stock markets in BRICs.

• Author: Ono, Shigeki
• Position: Brazil, Russia, India, and China

1. Introduction

   The year 1998 witnessed a serious decrease of crude oil prices, and futures prices of New York Mercantile Exchange light sweet crude oil fell to about USD10 per barrel. Oil prices, however, began to increase from the beginning of 1999 and their rise accelerated after 2003, hitting a record high of USD145 per barrel in July 2008. Because of the global financial turmoil in late 2008, oil prices plummeted to USD34 per barrel in February 2009, which have recently started to rise again. This situation has reinvigorated the debate on the effect of oil prices on the economy.

   Many studies have examined the influence of oil prices on the macroeconomy, stimulated especially by dramatic crude oil price increases because of unstable economic and political situations in the Middle East. Rasche and Tatom (1981) examined the impact of sharp increases in the price of energy on output in the U.S., Canada, France, Germany, Japan, and the U.K. Bruno and Sachs (1982) reported on relations between input price shocks and economic deceleration in the U.K. Darby (1982) conducted tests of significance in real income equations of oil-price variables for the U.S., the U.K., Canada, France, Germany, Italy, Japan, and the Netherlands. Hamilton (1983) analyzed the influence of the oil price increase on the U.S. output. Burbidge and Harrison (1984) discussed the impact of oil price increases on the price level and industrial output in the U.S., Japan, Germany, the U.K. and Canada. Gisser and Goodwin (1986) reported on relations between oil price increases and macroeconomic indicators of the U.S.

   While crude oil prices were over USD 30 per barrel at the beginning of the 1980s, they plunged to about USD 15 in 1986. Mork (1989) reported on the relationship between oil prices and GNP in the U.S. data, taking into account the large oil price decrease in 1986. He indicated that although Hamilton (1983) demonstrated a strong correlation between oil price increases and gross national product growth in U.S. data, the question of whether the correlation persists in periods of price decline remained unanswered. The empirical results of Mork (1989) suggest that the impact of the oil price increase and decreases on the U.S. output was asymmetric.

   Recent studies regarding the analysis of the influence of oil price shocks on the macroeconomy include Brown and Yucel (2002), Jimenez-Rodriguez and Sanchez (2005), Cunado and Perez de Garcia (2005), Cologni and Manera (2008), and Kilian (2008). Brown and Yucel (2002) presented a survey of the theory and evidence on the relationship between economic activity and oil prices. Jimenez-Rodriguez and Sanchez (2005) revealed that the effects of an increase in oil prices on real GDP growth were different from those of an oil price decrease, using data of G-7 countries, Norway and the Euro area as a whole. Cunado and Perez de Garcia (2005) indicated that oil prices have a significant effect on economic activity and price indices in six Asian countries, and found evidence of asymmetries in the oil prices-macroeconomy relationship for some countries. Cologni and Manera (2008) analyzed G-7 countries and suggested that for all countries except Japan and the U.K. the null hypothesis of an influence of oil prices on the inflation rate could not be rejected. Kilian (2008) estimated the effects of exogenous shocks to global oil production on inflation and real output in G-7 countries, and claimed that an exogenous oil supply disruption typically causes a temporary reduction in real GDP growth.

   All these articles have analyzed relations between oil price changes and macroeconomic indicators and clarified the influence on production levels. Yet they do not provide any information about the impact on stock prices, which are significant because stock prices reflect the expected earnings of companies and provide us with different aspects regarding the influence of oil price changes. There are few studies on the influence of oil price shocks upon stock markets. Jones and Kaul (1996) found that in the postwar period, the reaction of U.S. and Canadian stock prices to oil shocks could be explained by the impact of these shocks on real cash flows alone. The analysis of Sadorsky (1999) suggests that positive shocks to oil prices depress U.S. real stock returns while shocks to real stock returns had positive impacts on interest rates and industrial production. Conversely, Huang et al. (1996) argued that oil futures returns were not correlated with U.S. stock market returns. Ciner (2001) provides evidence that oil shocks affected U.S. stock index returns, applying nonlinear causality tests, and that the linkage between oil prices and the stock market was stronger in the 1990s. Park and Ratti (2008) revealed that oil price shocks had a statistically significant impact on real stock returns in the U.S. and 13 European countries while there was little evidence of asymmetric effects on real stock returns of positive and negative oil price shocks for oil importing European countries.

   Although these studies determined the relations between oil prices and stock prices, they have featured only developed countries, and the situations in developing countries have not been discussed. This paper focuses on Brazil, China, India and Russia (BRICs), or leading emerging economies with rapid economic growth, which cover about 45% of the world population and have significant influence on the global economy. The analysis of this paper clarifies differences of the impact of oil price futures on stock markets or companies' expected earnings among BRICs. Furthermore, this article covers the period of unprecedented oil price increases from 1999 through mid-2008, providing information about the impact of oil price changes that is not discussed in former studies.

   The outline of this paper is as follows. Section 2 describes the data sources for the analysis and methodological issues. Section 3 is a presentation of the empirical results. The last section presents the conclusions.

2. Data and Methodology

   This study applies a multivariate vector autoregressive (VAR) model with monthly data of BRICs. The period analyzed in this paper is set from January 1999 through September 2010 because it aims to analyze the impact of dramatic oil price increases and following decreases on stock prices. In the analysis, three indicators are used as variables: oil prices, stock returns, and industrial production.

   In accordance with former studies, linear and non-linear specifications of oil prices are used in the model. The value of linear specification of oil prices is calculated as the changes of...