Dynamic Relationships among GCC Stock Markets and Nymex Oil Futures

TLDR: The relationship between the stock markets of the GCC countries as an economic group and their links to the oil markets, despite the fact that the economies of these countries depend to a large extent on oil revenues and are thus susceptible to developments in the global oil market is very limited.

Abstract: 1. INTRODUCTION The Gulf Cooperation Council (GCC) is a customs union that consists of six members, including four major oil-exporting countries, which are important decision makers in the Organization of Petroleum Exporting Countries (OPEC). (1) The six members are Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and United Arab Emirates (UAE). The non-OPEC members among them are Bahrain and Oman. In January 2003, these countries collectively accounted for about 16% of the world's 76.5 million barrels a day of total production. They possess 47% of the world's 1018.8 billion barrels of oil proven reserves. (2) For these countries, oil exports largely determine foreign earnings and governments' budget revenues and expenditures; thus they are the primary determinant of aggregate demand. (3) The aggregate demand effect influences corporate output and domestic price levels, which eventually impacts corporate earnings and stock market share prices. This demand effect can also indirectly impact share prices through its influence on expected inflation, which in turn affects the expected discount rate. Such a strong oil influence on the national economy makes these countries primary targets for investigating the links between oil prices and the performance of their stock markets. There has been a large volume of work examining the relationships among international financial markets; a good deal of work has also been devoted to the links between spot and futures petroleum prices. In contrast, little work has been done on the relationships between oil spot/futures prices and stock markets. Virtually all of this work has concentrated on a few industrial countries, namely, Canada, Germany, Japan, the United Kingdom, and the United States. No work has been done on the relationship between the stock markets of the GCC countries as an economic group and their links to the oil markets, despite the fact that the economies of these countries depend to a large extent on oil revenues and are thus susceptible to developments in the global oil market. Moreover, because each GCC country depends on oil to a different degree, comparisons between them form an interesting subject for more investigation and analysis. Additionally, the Saudi stock market, which is 9th among emerging stock markets in terms of market capitalization in 2003, is the true leader of the GCC and is thus worthy of study on its own. Furthermore, these markets can provide an additional venue for international stock diversification and portfolio formation. For example, the total GCC market return increased by more than 9% in 2002; returns ranged from 32% for Qatar to less than 1% for Saudi Arabia. In contrast, the Standard & Poor's 500 (S & P 500) FTSE, and DAX declined by about 23%, 21% and 44%, respectively, in that down year (see Figure 1). Surprisingly, the overall literature on the links between oil markets and financial markets is very limited. Jones and Kaul (1996) investigated the reaction of the U.S., Canadian, Japanese and U.K. stock prices to oil price shocks using quarterly data. Utilizing a standard cash-flow dividend valuation model, they found that for the United States and Canada this reaction can be accounted for entirely by the impact of oil shocks on real cash flows. The results for Japan and the United Kingdom were not as strong. Huang et al. (1996) used an unrestricted vector autoregression (VAR) model to examine the relationship between daily oil futures returns and daily U.S. stock returns. They found that oil futures returns lead some individual oil company stock returns, but they do not have much impact on broad-based market indices, such as the S & P 500. In a more recent study, Sadorsky (1999), using monthly data (1947:1-1996:4), examined the links between the U.S. fuel oil prices and the S & P 500 in an unrestricted VAR model that also included the short-term interest rate and industrial production. In contrast with Huang et al. …