Hydrocarbon price spillover to banking performance in Eurozone

• Published date: 01 December 2023
• Author: Nahla Samargandi
• Date: 01 December 2023
• DOI: http://doi.org/10.1111/opec.12286

OPEC Energy Rev. 2023;47:255–270.

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INTRODUCTION

In 2008, the financial crisis that started in the United States and spread to the public sector triggered a financial melt-

down in Europe. The European banking industry transmitted the financial shocks from the US financial markets to

Europe. Major European banks were instrumental in raising capital from wholesale international markets, particularly

the money markets in the United States (Noeth & Sengupta,2012). Prior to Lehman Brothers' failure, international banks

accounted for over 40% of the assets of US prime funds, with European banks accounting for the majority. According

to some estimates, Eurozone banks' USD dominated assets peaked in 2010 at $3.2 billion (Coffey et al.,2009). European

banks have also financed credit and asset price booms in several European countries. These banks must not only be sys-

temically significant, but also substantial in terms of size; in some cases, their total assets are even more than the host

countries' GDP (Alqahtani,2018; Shin,2012).

The objective of this study is to determine how changes in real oil prices affect the Eurozone banking sector index. The

price of crude oil, which is a critical exogenous factor, is one of the most crucial causes of stock market volatility globally.

Consequently, investors should be aware of the prospective effects on stock returns of changes because of this factor (Le

et al.,2021; Shafaai & Masih,2013). Policy makers and investors alike could benefit from a deeper understanding of how

oil price shocks affect the financial system, allowing them to diversify/hedge their assets more effectively.

Oil price shocks can affect a wide range of activities, including macroeconomic indicators (Arora & Tanner,2013;

Li et al.,2012; Samargandi et al.,2020; Sohag et al., 2021), stock markets (Bastianin et al.,2016; Ding et al., 2017; Lee

et al.,2012; Sohag et al.,2022; Wang et al.,2013). Sadorsky(2001), Boyer and Filion(2007) and Lee et al.(2012) amongst

others also observed similar findings. In accord with prior empirical data, stock return and oil prices nexus follow a posi-

tive linkage in oil- exporting countries but trade- off relation in oil- importing countries. These studies, taken together, sup-

port the assumption that there is spillover of effects between the stock market and the commodity market; nonetheless,

the findings suggest that shock could have a negative or positive influence on market returns.

DOI: 10.1111/opec.12286

ORIGINAL ARTICLE

Hydrocarbon price spillover to banking performance in

Eurozone

NahlaSamargandi1,2

© 2023 Organization of the Petroleum Exporting Countries.

1Department of Economics, Faculty of

Economics and Administration, King

Abdulaziz University, Jeddah, Saudi

Arabia

2Center of Research Excellence in

Renewable Energy and Power Systems,

King Abdulaziz University, Jeddah,

Saudi Arabia

Correspondence

Nahla Samargandi, Department of

Economics, Faculty of Economics

and Administration, King Abdulaziz

University, Jeddah 21589, Saudi Arabia.

Email: nsamrgandi@kau.edu.sa

Abstract

The current study investigates the impact of real oil price shocks on the Eurozone

banking sector from February 2009 to February 2022, using the Structural Vector

Autoregressive method to distinguish the reaction between Eurozone bank

indices and three structural indicators in the oil market shocks. The shocks

include global oil demand, supply shock, and specific oil market shocks. Our

findings show that the banking sector in the Eurozone responds positively toward

an oil- specific demand shock (oil price) in the short run, but it responds negatively

in the medium and long run that lasts for a long time. The banking sector, on

the contrary, does not react to supply shocks, which provide a significant policy

implication for regulators and policymakers.

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SAMARGANDI

Akhtaruzzaman et al.(2021a) point out that gold appears to be a short- term haven asset for the S&P 500, Euro Stoxx,

Nikkei 225 and WTI crude oil indexes during the COVID- 19 peak periods. Over the COVID- 19 crisis, gold may have

served as a ‘flight- to- safety’ asset for investors. In a similar study, by Akhtaruzzaman et al.(2021b) highlighted the influ-

ence of the COVID- 19 pandemic on oil prices. The study observed that increasing oil price risk favours oil providers, but

rising oil prices harm oil customers and the financial sector. In addition, it appears that COVID- 19 has benefited both

financial and non- financial firms.

The impact of oil price shocks has been investigated, with a particular emphasis on the effects on different sectors of

the economy to identify how each sector responds to the shocks (Lee et al.,2012; Sohag et al.,2021, 2022). This assumes

that sectoral analysis provides more extensive data that can be used to create effective asset allocation and risk manage-

ment strategies (Arouri et al.,2011). In line with this, it was found that oil price fluctuations' influence on firms' stocks is

diverse; thus, using a composite measure may result in aggregation bias (Mollick & Assefa,2013).

Thus, our study contributes in two ways to the current literature on the equity- oil nexus. First, the Eurozone's bank-

ing sector, which has received less attention than oil prices, macroeconomic indicators, or aggregate stock markets, is

crucial to economic and financial stability in the Eurozone and globally. Secondly, in terms of methodology, we employ

the Kilian(2009) concept to differentiate between supply and demand shocks in the oil market. According to Kilian and

Park(2009), empirical research that fails to differentiate between these demand and supply shocks risks capturing the re-

action of equity returns to the impact of crude oil average prices, skewing their findings towards concluding no influence

or ambiguity. Finally, we use five different Eurozone banking indices to verify the validity of our findings. Based on the

findings of our current article, which explores the link between bank indices and oil prices, we are able to uncover new

areas for international portfolio diversification, hedging and trading methods as a result of our current research (Arouri

et al.,2011; Simpson,2009; Wang et al.,2013).

The rest of the paper is organised as follows: Section2 includes the Literature Review, Sections3 and 4 contain the

Data and Methodology, Section5 has the Empirical Analysis and Results, and Section6 contains the Conclusion.

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LITERATURE REVIEW

Finance theory reveals a few mechanisms that hydrocarbon prices can influence the stock market. The cash flow theory

suggests the shortest communication path. Changes in future expected cash flows and discount rates, according to this

theory, have a direct impact on stock returns. Thus, if the corporation regards oil as either an input or an output, a hike

of oil price, for example, might have both positive and negative effects on the firm's future expected cash flow (Mohanty

et al.,2011; Sohag et al.,2023). According to Kollias et al.(2013) stock prices are influenced by market mood and the

rising price of crude oil. For the first time in history, oil has become a financial asset that can be traded in spot and future

markets, used to diversify portfolios, and hedge against inflation (Mensi et al.,2017).

Many studies, using a variety of econometric techniques, emphasise the dynamic linkage between crude oil price re-

turns and stock market indexes in a range of countries. Some of the prior studies applied GARCH- related framework or

GARCH- filtered series to investigate volatility spillover between oil and financial indicators such as exchange rates, stock

indices, amongst others. Malik and Ewing(2009), for example, utilise the BEKK- GARCH (1,1) model to investigate the

volatility transmission between US sector indices and the oil price. The study assumed a strong volatility and spillover of

shocks between the stock markets and oil market. Furthermore, previous studies are being expanded. There are a range

of GARCH- type models that can be used to assess conditional heteroskedasticity volatility and spillover impact, but

they all focus on a single conditional mean, ignoring the asymmetric features between the stock returns and oil prices.

Hence, quantiles must be used to do this. Zhu et al.(2016) examined Chinese real- estate stock market returns from 1994

to 2014 using a quantile regression model. According to these studies, there is a strong link between stock market returns

and oil prices; however, it varies by sector. As a result, only a few attempts to scrutinise the linkage between oil prices

and the market for sectoral indices have been made, with a focus on various types of hydrocarbon prices shocks. In this

section, however, this study considers studies that employed structural VAR frameworks to explore the oil- equity link in

advanced economies and distinguish between three sorts of shocks that previous methodologies overlooked.

Several studies have suggested that an oil supply shock may have little or no impact on stock returns. For example,

the empirical findings of Apergis and Miller(2009) and Güntner (2014) show that oil supply shocks have little impact

on stock returns in industrialised countries. Valenti et al.(2018) used a structural VAR model to distinguish between

three types of oil price shocks while studying the impact of oil price shocks on US stock market volatility. Their findings

suggest that unexpected changes in aggregate and oil- specific demand, but not supply shocks, have a significant impact