Assessing Literatures on the Dependence of Stock Market Development on Upstream Oil Royalty Revenue and Systematic Risk Factors: Highlighting the Relevance of Dutch Disease Theory and Capital Asset Pricing Model

Abstract

The paper assessed past literatures on the dependence of stock market financial development on upstream oil royalty revenue account and systematic risk factors and evaluating the relevance of Dutch Disease theory and capital asset pricing model. Theoretical approach supports the role of oil royalty revenue vis-à-vis oil price volatility, foreign exchange rate risk, financial liquidity risk and interest rate risk in determining the performance and financial development of stock market. It is well documented in research that stock prices react to information on oil revenue, crude oil production, monetary policy interest rate, foreign exchange rate uncertainty and diaspora cash remittances. Traditional valuation of stock is based on capital asset pricing model but the modern relevance is in doubt due to anomalous performance of investors and behavioural sentiments. Stock markets of emerging economies over the past few decades have witnessed remarkable growth as indicated by the value and volume of trade in the markets along with the level of capital inflows from developed markets, thereby providing numerous opportunities for investments. The development of the stock market is vital as it provides more opportunities for greater mobilization of funds from with and diaspora remittances and better efficiency in resource allocation. Nevertheless, investment returns in the stock market of developing economies continue to be more reactive to changes in economic fundamentals due to their fragile and volatile nature. This makes them even more unpredictable and unstable unlike the stock markets of developed economies, which are known to be more stable. Stock market financial development is not symptomatic of Dutch Diseases based on the fact that Oil-induced Dutch Disease assumes an oil sector which largely contributes to the economy while so many vital systematic risk factors affects stock market development. Optimistically this study along with other previous and future studies will increase the knowledge about Dutch Disease and will contribute to lessen the harmful effects that Dutch Disease causes. In spite of the common perception that oil is extremely important for financial and economic dynamics, there is, unexpectedly, a dearth of research on how oil revenue and prices influence stock market financial development.