Oil prices and stock market price in Nigeria

• DOI: http://doi.org/10.1111/opec.12013
• Published date: 01 March 2014
• Date: 01 March 2014
• Author: Philip Ifeakachukwu Nwosa

Oil prices and stock market price in Nigeria

Philip Ifeakachukwu Nwosa*

*Assistant Lecturer, Department of Accounting, Economics and Finance, College of Management

Sciences, Bells University of Technology,P. M. B. 1015 Ota, Nigeria. Email: nwosaphilip@yahoo.com

Abstract

This paper examined the relationship between oil prices (international oil price and domestic oil

price) and stock market price in Nigeria for the period spanning 1985:1 to 2010:4.The study utilised

the Johansen’s multivariate cointegration test and the vector error correction model (VECM). The

Johansen’s test showed that the variablesare cointegrated, and the cointegration equation revealed

that oil prices have significant relationship with stock market price in the long run.The VECM esti-

mate only revealeda unidirectional causality from stock market price to international oil price in the

long run. A unidirectional causality wasalso obser ved from domestic oil price to stock marketprice

in the long run. The study recommended that policymakers, financial analyst and shareholders

should into cognizance changes in international oil price and domestic oil price in their financial

decisions given the significant impact of oil prices on stock market price in Nigeria.

1. Introduction

Oil price increases are assume to affect stock market price through the future cash flowsof

companies and through the interest rate use in discounting the future cash flows (Miller

and Ratti, 2009; Basher et al., 2010). Given the indispensable impact of oil in the produc-

tion process, rising oil prices are usually accompanied by rising production costs. In the

absence of complete transfer of increased production cost to the consumers, such

increased costs result in a decline in profit and consequently, a decline in shareholders’

return and stock price. Also, rising oil prices reduce consumers’ disposable income spent

on the purchases of goods and services. The combine effect of increased production cost

and a decline in consumers demand culminates in reduce profits and dividends that are key

drivers of stock prices (Basher and Sadorsky, 2006; Al-Fayoumi, 2009).Apar t from the

above, rising oil prices have been observed to be inflationary and monetary authorities

often respond with contractionary policy measures (such as raising short term interest

rates) that affects the discount rate used in stock pricing formula (Basher et al., 2010).

Higher interest rates also make bonds look more attractive than stocks leading to a fall in

stock prices (Basher and Sadorsky,2006).

JEL Classification: G12, Q49

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Based on the above theoretical exposition, studies have been conducted empirically

to examine the nature of the relationship between oil price and stock market price. Most

studies in this regard exist for developed oil importing countries, and their results can

best be described as inconclusive. Studies by Arouri and Rault (2010), Oberndorfer

(2009), Park and Ratti (2008) and O’Neill et al. (2008) among others observed a signifi-

cant negative relationship between oil price and stock return, whereas studies by Le

and Chang (2011) and Masih et al. (2011) observed a positive relationship between

oil price and stock price. Also, studies by Sari and Soytas (2006), Maghyereh (2004),

Cong et al. (2008) and Huang et al. (1996) do not observe any relationship between oil

price and stock market return. The inconclusiveness on the oil price–stock market price

relationship in the literature provided strength for this study to examine this issue in an

oil exporting–developing economy like Nigeria. Apart from the above, studies by

Al-Fayoumi (2009), Bjornland (2009) and Jiménez-Rodríguez and Sánchez (2005)

argued that an oil price increase is expected to have a positive effect in an oil exporting

country, as this would lead to increase in national income. The increased income is

expected to result in increase expenditure and investment on infrastructures and other

mega projects, which in turn would create greater productivity (Filis et al., 2011). Such

investments are expected to stimulate the stock markets positively and hence stock

market price. This study therefore examined this hypothesis within the context of the

Nigerian economy.

In addition to the forgoing raised issue, it is worthyof note that domestic oil price (such

as petrol) has witnessed sudden upward price reviewsat different times by different politi-

cal administration. Such domestic oil price upward reviews have generated intense

responses from the general public particularly the households and business units, because

such increase in domestic oil price acts as inflationary tax on producers and consumers by

increasing firms’ production cost and reducing consumers’ disposable income, respec-

tively. Given the high dependence of productive firms in Nigerian on domestic oil in the

production process, especially in the face of the epileptic nature of electricity supply,the

combine effect of the above wouldundoubtedly affect future cash flow of firms in Nigeria

through reduction in profit and may also adversely affect stock market price.Also, given

the inflationary consequence of increased domestic oil price on the general price level, the

response of the Central Bank of Nigerian (CBN) could also adversely affect stock market

price through its impact on the discount rate used in stock pricing formula. Based on the

above argument, the following research questions are raised: (i) does international crude

oil price (IOP) influence stock market price in Nigeria?; and (ii) does stock market price

respond to changes in domestic oil prices (DOP) in Nigeria?

As argued above, studies have examined the relationship between oil price and stock

market price in developedoil impor ting countries, whilein developing countries, there is a

lack of literature in this gap in knowledge.With respect to Nigeria, studies on oil price have

Philip Ifeakachukwu Nwosa60

OPEC Energy Review March 2014 © 2014 Organization of the Petroleum Exporting Countries