The Nexus between the Oil Price and Stock Market: Evidence from South Asia

Abstract

The link between stock market prices and oil prices has drawn considerable attention in recent decades because the risk and uncertainties associated with oil price volatility affect investor’s portfolios, particularly, those investors seeking to make optimal portfolio allocations. This paper investigates the relationship between the oil price and the stock market index in South Asia. Based on a sample of four countries, namely Bangladesh, India, Pakistan, and Sri Lanka for the period 1997-2017, we use the nonlinear Autoregressive distributed model estimated by Pooled Mean Group (PMG) estimator. We show that there is a positive relationship between the world oil price and stock market index; and that the response of stock market index to positive and negative oil price shocks are asymmetric. Counter to prior research in developing countries, our findings imply that higher oil prices in the world market stimulate stock prices which suggests that the stock markets in the South Asian region do not follow the Efficient Market Hypothesis (EMH) for which the shocks in the crude oil market are not rationally signaled in the financial market. Another plausible justification of this movement in the same direction, as explained by Bernanke (2016), is that both oil price and stock prices are reacting to a change in some common underlying factor, which he calls the global aggregate demand and market risk aversion.