The influence of oil price uncertainty on stock liquidity

• Published date: 01 February 2023
• Author: Qin Zhang,Jin Boon Wong
• Date: 01 February 2023
• DOI: http://doi.org/10.1002/fut.22383

Received: 5 December 2021

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Accepted: 7 September 2022

DOI: 10.1002/fut.22383

RESEARCH ARTICLE

The influence of oil price uncertainty on stock liquidity

Qin Zhang |Jin Boon Wong

Macquarie Business School, Macquarie

University, Sydney, New South Wales,

2109, Australia

Correspondence

Qin Zhang, Macquarie Business School,

Macquarie University, Sydney, NSW

2109, Australia.

Email: qin.zhang3@mq.students.edu.au

Abstract

Using high‐frequency intraday data, this study provides strong empirical

evidence that elevated oil price uncertainty has a significant and negative

influence on stock liquidity. More specifically, the results suggest that large

oil‐related corporations are most affected, followed by small‐listed firms more

generally. Further analysis reveals that liquidity providers widen the bid‐ask

spreads to protect themselves during periods of high oil price uncertainty for

large‐listed firms, particularly those in the oil industry. These findings are

robust to various measures of oil price uncertainty, different market

conditions, structural break analysis and show the influence of oil price

movements extends to stock liquidity.

KEYWORDS

bid‐ask spreads, information asymmetry, market behavior, oil uncertainty, stock liquidity

JEL CLASSIFICATION

G12, G14, G32, Q40, Q41

1|INTRODUCTION

The coronavirus (Covid‐19) crisis in 2020 has several important implications for the world economy. Amongst the

numerous effects, one key observation is the affirmation of a strong correlation between crude oil utilization and

developments in global markets. For instance, the OECD and World Bank estimate clearly show a severe decline in oil

consumption and oil prices in 2020 due to Covid‐19, which further coincides with a 5.2% forecasted contraction in

global GDP in 2020.

1

Further, the relevance of oil prices is evident as the specter of a USD $100 crude oil escalates

concerns about inflationary pressure on the costs of living, which is of considerable interest to investors, policymakers,

and academics (e.g., Bernanke, 1983; Crawford et al., 2021).

2

These elements reaffirm that despite concerns about

climate change and the advent of alternative energy sources, crude oil remains an integral cog in the global economy

and international financial markets (e.g., Irwin et al., 2009; Ready, 2018).

J Futures Markets. 2023;43:141–167. wileyonlinelibrary.com/journal/fut

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This is an open access article under the terms of the Creative Commons Attribution‐NonCommercial‐NoDerivs License, which permits use and distribution in any

medium, provided the original work is properly cited, the use is non‐commercial and no modifications or adaptations are made.

© 2022 The Authors. Journal of Futures Markets published by Wiley Periodicals LLC.

1

https://www.oecd.org/coronavirus/policy-responses/the-impact-of-coronavirus-covid-19-and-the-global-oil-price-shock-on-the-fiscal-position-of-oil-

exporting-developing-countries-8bafbd95/ https://www.worldbank.org/en/news/press-release/2020/10/22/impact-of-covid-19-on-commodity-

markets-heaviest-on-energy-prices-lower-oil-demand-likely-to-persist-beyond-2021 https://www.worldbank.org/en/news/feature/2020/06/08/the-

global-economic-outlook-during-the-covid-19-pandemic-a-changed-world

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https://www.bloomberg.com/news/articles/2022-02-13/-100-oil-threatens-to-compound-world-economy-s-inflation-shock

Given the importance of oil as an essential input, either directly or indirectly for companies, its price

movements can present a source of significant uncertainty. This can adversely affect firms' input costs, cash flow,

profitability, valuation, investments, and corporate payouts (e.g., Wong & Hasan, 2021; Wong & Zhang, 2020),

which have substantial flow‐on effects on financial markets (Wong, 2021;Xiaoetal.,2018). However, despite

numerous studies investigating the impacts of oil price movements on financial markets, an important issue that

remains unexplored is the connection between oil price uncertainty and stock liquidity. This paper seeks to fill the

gap in the literature.

3

The market microstructure literature provides extensive evidence on the value of understanding stock liquidity, as it

is central to the efficient functioning of trade and investor confidence in the financial markets (Schoenfeld, 2017). Prior

studies document that stock liquidity is determined in part by information asymmetry among traders, which can have a

considerable impact on the cost of capital (Amihud & Mendelson, 1986,2000; Butler et al., 2005). This well‐established

theory suggests that greater information asymmetry among market participants translates into lower liquidity and

higher transaction costs for stocks. This invariably raises the required rate of return and hence lowers current stock

prices, which presents a higher cost of capital (e.g., Copeland & Galai 1983; Diamond & Verrecchia 1991). While prior

studies have shown that during periods of high information asymmetry (e.g., earnings announcements), stock liquidity

is reduced as market makers are either reluctant to provide bid‐ask quotations or protect themselves with wider bid‐ask

spreads (e.g., Kim & Verrecchia, 1994; So & Wang, 2014); the extent to which information asymmetry created by oil

price uncertainty can impact stock liquidity remains unexplored. In the context of our paper, since oil price uncertainty

can adversely impact corporate earnings and cash flow (Crawford et al., 2021), we postulate that it can create

information asymmetry regarding the valuation of a company (Zhang & Wong, 2022a) and thus negatively impact stock

liquidity.

Using an extensive high‐frequency intraday data set comprising all trade and quote information, this study

contributes to both the energy finance and market microstructure literature by investigating whether the influence of

crude oil price in financial markets extends to stock liquidity. We employ a fixed effects regression, quantile regression

to proxy for different market conditions, and structural break analysis across multiple sub‐samples, along with

alternate measures of stock liquidity and oil uncertainty, to comprehensively examine this issue.

4

It is noteworthy that

the literature advocates the use of high‐frequency tick‐by‐tick intraday data over low‐frequency data, as it can provide

more extensive insights (e.g., Brogaard et al., 2014; Le & Gregoriou 2020). These insights are likely to be more beneficial

for market participants involved in liquidity provision activities or are significant consumers of stock liquidity, such as

institutional investors, mutual funds, and so forth.

The empirical findings from this paper support the assertation that uncertainty arising from oil price volatility

has a significant effect on stock liquidity at the firm level. In general, an increase in oil price uncertainty

consistently leads to a substantial reduction in stock liquidity. More specifically, we provide new insights through

evidence that suggests heightened oil uncertainty has more impact on the stock liquidity of smaller relative to

larger firms for the broad market, oil‐user, and oil‐substitute groups. In contrast, results reveal the opposite for oil

and oil‐related companies. They indicate that the stock liquidity of large oil corporations is more impacted by oil

uncertainty compared to smaller firms. Further analysis shows that despite substantial increases in bid‐ask

spreads during periods of heightened oil price uncertainty, a considerable amount of these hikes for large

companies may be attributed to market makers' protecting themselves from greater adverse selection costs

created by higher information asymmetry. This effect is particularly pronounced for large oil corporations

relative to all other firms.

The remainder of this paper is organized as follows. The following section provides a brief literature review. The

third section presents the data and methodologies that are used in this study. The fourth and fifth sections present

the empirical results and additional robustness tests, r espectively. The conclusions are provided in the final

section.

3

A review of the literature reveals three papers on oil price movements and stock liquidity to date (i.e., Sklavos et al., 2013; Zhang & Wong, 2022a;

Zheng & Su, 2017). It is noteworthy that Sklavos et al. (2013) focus on the general stock liquidity of energy stocks in the United States, and both

Zhang and Wong (2022a) and Zheng and Su (2017) emphasize the distinctive impact of different types of oil price shocks on stock liquidity in the US

and China, respectively. To the best of the authors' knowledge, this is the first study to specifically examine the potential influence of oil price

uncertainty on stock liquidity.

4

E.g., Lepone & Wong (2017), Lepone & Wong (2018), Hasan et al. (2022a), Hasan et al. (2022b), Wong & Zhang (2022a), Wong & Zhang (2022b), Xin

et al. (2021), Zhang & Wong (2022b).

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