Abstract
BackgroundThe aim of this study is to investigate the effect of the oil price and its volatility on the stock market of Pakistan before and after the 2007 financial crisis period.MethodsThe analyses are carried out on daily data for the period from July 31, 2000 to July 31, 2014. This study uses several econometric techniques for the analyses, namely, the Johansen-Juselius cointegration test, generalized autoregressive conditional heteroskedasticity (GARCH) model, exponential generalized autoregressive conditional heteroskedasticity (EGARCH) model, variance decomposition method, and impulse response function.ResultsThe results of the cointegration method indicate a significant long-run association between stock market and oil prices in the pre-crisis period. The EGARCH model shows that oil price returns have a significant effect on stock market returns in both sub-periods, while the result for the GARCH model is significant only in the post-crisis period. We find a significant effect of oil price volatility on the stock market in both sub-periods from the GARCH model. Furthermore, the EGARCH model shows an asymmetric effect of oil price volatility on the stock market in the pre-crisis period. Variance decomposition shows that stock market variations are mostly explained by self-innovation. Moreover, the impulse response function results show that oil price shocks affected the stock market adversely in the pre-crisis period but positively in the post-crisis period.ConclusionsThis study suggests that economic policymakers and investors should consider the oil price as an important factor affecting stock market returns.
Highlights
The aim of this study is to investigate the effect of the oil price and its volatility on the stock market of Pakistan before and after the 2007 financial crisis period
The generalized autoregressive conditional heteroskedasticity (GARCH) and exponential generalized autoregressive conditional heteroskedasticity (EGARCH) methods were applied to test the effects of oil price returns and oil price volatility on the stock market of Pakistan
We applied a variance decomposition test to understand the forecast variance and impulse response function in order to analyze the effect of the oil price shock on the financial market
Summary
The aim of this study is to investigate the effect of the oil price and its volatility on the stock market of Pakistan before and after the 2007 financial crisis period. It is widely argued that the behavior of a stock market mostly depends on the economic performance and political environment of the country. The smooth performance of the stock market is relatively important for developed and emerging economies. Oil is an important source of energy that is important for maintaining smooth economic performance of industries that depend on oil or oil products. Oil is required for the economic performance of emerging economies, including Pakistan. Pakistan’s domestic production of oil is relatively lower than its consumption, and the Jebran et al Financial Innovation (2017) 3:2 country relies heavily on oil imports. A visual examination of Fig. 1 clearly shows that the economy produces a relatively small proportion of total consumption
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