Further Evidence on the Responses of Stock Prices in GCC Countries to Oil Price Shocks

I. INTRODUCTION There has been a large volume of studies on linkages between oil prices and macroeconomic variables. Most of these studies have established the significant effects of oil price changes on economic activity for several developed and emerging countries (see, e.g., Cunado and Perez de Garcia, 2005; Balaz and Londarev, 2006; Gronwald, 2008; Cologni and Manera, 2008; Kilian, 2008). Furthermore, some papers have shown that the link between oil and economic activity is not entirely linear and that negative oil price shocks (price increases) tend to have larger impacts on growth than do positive shocks (see, e.g., Hamilton, 2003; Zhang, 2008; Lardic and Mignon, 2008). In sharp contrast to a significant number of works investigating the link between oil price shocks and economic activity, there have been relatively few attempts to study the relationship between oil price variations and stock markets. Moreover most of these efforts have focused on industrial countries such as the United States, Canada, the European community, and Japan. In regards to emerging market economies, our survey of the literature generally indicates that very few studies have been carried out and that they mainly consider the short-term interactions between energy price shocks and equity prices. One rationale for using oil price fluctuations as a risk factor affecting stock prices is that in theory the fair value of a stock equals the sum of expected future cash-flows discounted at the investor's required rate of return. These cash flows are naturally affected by macroeconomic events that potentially depend on oil shocks. Therefore, oil price changes may influence stock prices. Most previous studies have investigated this relationship within the framework of a macroeconomic model employing data from net oil importing countries obtained at low frequencies (monthly or quarterly). Using weekly data and new asymmetric cointegration tests, this article attempts to investigate both the short- and long term relationships between oil price shocks and stock markets in the Gulf Cooperation Council (GCC) countries. A study of the possible links between oil prices and stock markets in the GCC countries is interesting for several reasons. First, since these countries are major suppliers of oil in today's world energy markets, their stock markets are more likely to be susceptible to changes in response to oil price fluctuations. Second, the specific characteristics shared by the GCC stock markets, as compared to those of markets in developed and other emerging countries, indicate a need for in-depth analysis of the oil-equity market relations. In effect, they are largely independent of the international markets and are overly sensitive to regional political events. Finally, GCC markets represent a very promising area for regional and international portfolio diversification. For this reason the empirical results of studies centered on the GCC countries are of great importance for investors seeking to make judicious investment decisions, and for policymakers attempting to regulate stock markets more effectively. In the related literature, Jones and Kaul (1996) perform pioneer work in testing the reaction of international stock markets (Canada, UK, Japan, and USA) to oil price shocks, based on the standard cash-flow dividend valuation model. They find that for the US and Canada this reaction can be entirely accounted for by the impact of the oil shocks on cash flows. The results for Japan and the UK were inconclusive. Using an unrestricted vector autoregressive (VAR) model, Huang et al. (1996) show a significant link between the stock returns of certain American oil companies and oil price changes. There is however no evidence of a relationship between oil prices and market indices such as the S&P 500. In contrast, Sadorsky (1999) applies an unrestricted VAR with GARCH effects to American monthly data and shows a significant relationship between oil price changes and aggregate stock returns in the US. …