Crude oil prices give information about stock returns

Crude Oil is the important input of modern economic systems. As states urbanize and renovate their demand for oil raises drastically. Potential demand for oil is difficult to calculate but is normally extremely correlated with the growing in industrial production. Therefore, states sing headlong economic growing are the 1s likely to significantly magnify their demand for rough oil. Increases in oil demand without equalising additions in supply lead to higher rough oil monetary values. Higher rough oil monetary values act like an rising prices revenue enhancement on consumers and manufacturers by 1 ) plumping the sum of disposable income consumers have left to pass on other goods and services and 2 ) increasing the costs of non-oil bring forthing companies and, in the absence of to the full go throughing these costs on to consumers, droping net incomes and dividends which are cardinal drivers of stock monetary values. In add-on to worldwide demand and supply conditions, rough oil monetary values besides respond to geopolitics, institutional agreements ( OPEC ) , and the kineticss of the hereafters market ( Sadorsky, 2004 ) . Unanticipated alterations in any of these four factors can make volatility, and therefore hazard, in oil hereafters monetary values. Oil Price volatility increases hazard and uncertainness which negatively impacts stock monetary values and reduces wealth and investing.

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One macroeconomic factor that is having increasing empirical attending is rough oil. A cardinal factor input, rough oil monetary values have the possible to dramatically change the fiscal public presentation of national economic systems and the houses that operate in this. it is sensible to anticipate that stock markets are deeply influenced by oil monetary value alterations, unusually small empirical grounds exists. Sadorsky ( 2001 ) argues that there has been a big volume of work look intoing the links among international fiscal markets, and some work has besides been devoted to the interaction among rough oil topographic point and future monetary values. In contrast, small work has been done on the relationship between oil spot/futures monetary values and stock indices. Even the findings of the extant work are assorted. Poon and Taylor ( 1991 ) found no grounds of an oil monetary value factor in the U.S. and Japan, severally. In contrast, Sardorsky ( 1999 ) concluded that oil monetary values were a important factor in the U.S. Jones and Kaul ( 1996 ) , Faff and Brailsford ( 1999 ) , Sardorsky and Henriques ( 2001 ) , and Sardorksy ( 2001 ) have besides examined the impact of oil monetary value factors with disparate consequences. While these surveies have provided at least some grounds that oil monetary values represent a beginning of systematic plus monetary value hazard, and that the exposure to this hazard varies across industries, no recent work is known in the Pakistani context.

Statement of Problem

At least since the development of the capital plus pricing theoretical account, a literature has sought to place the determiners of plus monetary values and returns. Given the capital plus pricing theoretical account rests on the premiss that assets are priced harmonizing to their covariance with the market portfolio, the increasing credence that other pricing factors, particularly macroeconomic factors, should besides be modeled has led to yet farther polishs, most notably in the signifier of the arbitrage pricing theory. With this multifactor specification as a starting point, an increasing figure of empirical surveies have sought to look into whether macroeconomic variables constitute a beginning of systematic plus monetary value hazard at the market and industry degree ( Antoniou et al. ( 1998 ) , Faff and Chan ( 1998 ) , Canova and Nicolo ( 2000 ) ) . The cardinal enterprise of this analysis is to happen out whether macroeconomic information, peculiarly rough oil monetary values, gives incremental information beyond the market portfolio about the behaviour of industry stock returns


Crude oil being the nucleus input of productions it has been assumed that alterations in rough oil monetary value significantly changes the cost of production. Therefore an addition in rough oil monetary value leads to higher cost of production. Consequently higher cost of production leads to take down net income borders or it forces manufacturer to increase the monetary value of the goods. And increase in monetary value of goods leads lower demand for the good resultantly gross revenues of the house goes down and overall profitableness suffer. Further more steadfast doing bantam or negative net income loses investors ‘ assurance and its stocks monetary value go down which leads to negative stock returns and frailty versa. Following hypotheses are suggested:

H1: alteration in oil monetary values has significantly impact on the stock returns of car and parts sector of Pakistan

H2: alteration in oil monetary values has significantly impact on the stock returns energy sector of Pakistan

H3: alteration in oil monetary values has significantly impact on the stock returns Chemical and Pharmaceutical sector of Pakistan

H4: Change in oil monetary value has different impact on the stocks return of different industrial sectors.


Asset monetary values are by and large believed to react sensitively to macroeconomic intelligence. Every twenty-four hours experience gives the feeling to back up the observation that single plus monetary values are influenced by a wide scope of unannounced events and that assorted events have a more relentless impact on plus monetary values than do others ( Faff and Chan, 1998 ) . Therefore macroeconomic intelligence is of import factor in the account of stock returns at the industry degree.

In recent old ages at that place have been legion surveies which argued that stock monetary values non merely retroflex alterations in current and future hard currency flows and awaited returns, but are besides determined by bad kineticss that is investor attitude and/or overreaction to intelligence. Many research workers have claimed that the strong predictability of stock returns over assorted skylines is cogent evidence of such crazes. In an enterprise to mensurate whether the predictability of stock returns is rational, several recent surveies tested whether utilizing Capital Asset Pricing Model ( CAPM ) or a more general plus pricing theoretical account like the Arbitrage Pricing Theory ( APT ) could extinguish or ex-plain their predictability. If factors and/or their conjugate hazards can explicate the predictability of stock returns so the market is converting, and frailty versa ( Fama and French, 1989 ) .

The attack taken in this paper uses a planetary multi-factor theoretical account that permits for both unconditioned and conditional hazard factors. This attack is related to the international capital plus pricing theoretical account ( CAPM ) , the deductions of which have been studied by Brealey & A ; Myers, ( 2003 ) . Whereas the focal point of the CAPM is on market hazard, the multi-factor theoretical account includes multiple beginnings of hazard ( Ross, 1976 ) . The CAPM and multi-factor theoretical accounts are indispensable edifice blocks of modern-day portfolio theory. In both theoretical accounts, expected returns are linearly connected to put on the line factors and hazard premiums. So far the CAPM has been loosely tested both domestically and internationally and the general understanding is that the CAPM explains no statistically important correlativity between systematic hazard ( beta ) and returns ( Fama & A ; Gallic 1992 ) .

Modern economic systems are more energy efficient presents than they were 40 old ages ago with oil use per dollar of GDP less than half of what it was in the 1970s. This addition in energy efficiency has happened because of inexpensive energy strength through technological modernisation and more dependance on a broadened scope of energy beginnings ( like a greater mix between non-renewable and renewable energy beginnings ) . Emerging and new economic systems tend to be more energy intensive than more developed economic systems and are hence more open to high oil monetary values. Consequently, oil monetary value alterations are likely to hold a larger impact on net incomes and stock monetary values in emerging economic systems.

Past pattern has shown that oil monetary value dazes have a much bigger impact on the poorer states in the universe. The OPEC oil trade stoppage of 1973, which raised the monetary value of oil from $ 3 per barrel to $ 13 barrel in merely over a few short months, created existent economic and societal destitution for developing states by increasing their costs of imported petroleum oil. Worldwide imparting institutes like the World Bank and the International Monetary fund ( IMF ) had to allow loans to developing states so that they could maintain on with their economic development undertakings ( Canova, 2000 ) .

If rough oil plays a critical function in an economic system, one would expect alterations in oil monetary values to be interrelated with alterations in stock monetary values. Specifically, it can be argued that if oil influences existent economic activity, it will impact net incomes of those concerns in which rough oil is ( straight or indirectly ) a factor of production. Thus, a crestless wave in rough oil monetary value would do jutting net incomes to alter, and this would take to an immediate alteration in stock monetary values if the stock market expeditiously capitalizes the hard currency flow propositions of the oil monetary value additions. ( Canova and Nicolo, 2000 ) .

Sadorsky ( 2003 ) exercised monthly informations from July 1986 to April 1999 to analyze the macroeconomic determiners of U.S. engineering stock monetary value conditional volatility. Sadorsky ( 1999 ) projected a vector car arrested development theoretical account with monthly informations to jam the association between oil monetary values alterations and stock returns in the United States. In his analysis, he found that oil monetary value change and oil monetary value volatility both play critical functions in impacting stock returns. The matter-of-fact consequences indicated that the conditional volatilities of industrial production, oil monetary values, the default premium, the federal financess rate, the foreign exchange rate, and the consumer monetary value index each have a important impact on the conditional volatility of engineering stock monetary values.

Harmonizing to McSweeney and Worthington ( 2007 ) excess returns in the retailing industry are negatively connected to the oil monetary value factor. A latent account for the ascertained negative consequence is the influence of oil monetary value additions on consumer discretional disbursement. Since the monetary value of oil get higher relation to other goods and as a per centum of family outgo, the nondiscretionary character of family crude oil disbursals, at least in the short-run, restricts the sum of discretional financess presented to consumers. This ought to take down the returns on retail houses.

Basher and Sadorsky ( 2006 ) studied the influence of oil monetary value on 19 emerging equity markets including Pakistan. They found strong cogent evidence that oil monetary value hazard influences stock monetary value returns in emerging equity markets while the precise relationship depends, to some extent, on the information frequence being used. The conditional association is non yet symmetrical. For day-to-day and monthly informations, positive oil monetary value alterations have a positive consequence on excess equity market returns in emerging economic systems. For hebdomadal and monthly informations, negative oil monetary value alterations have positive and important effects on emerging equity market returns.

Faff and Brailsford ( 1999 ) in their survey found that the grade of pervasiveness of an oil monetary value factor, beyond the influence of the market, is detected across some Australian industries, positive oil monetary value sensitiveness in the Oil and Gas and Diversified Resources industries and likewise they found important negative oil monetary value sensitiveness in the Paper and Packaging, and Transport industries. By and large, they revealed that long-run effects persist, although they hypothesize that some houses have been able to go through on oil monetary value alterations to clients or fudge the hazard.

Mohan Nandha, and Faffa ( 1999 ) analyzed 30 five planetary industry indices for the period of 22 old ages from April 1983 to September 2005.They indicated that oil monetary value ascent has a negative impact on stock returns for all industries apart from excavation, and oil and gas sectors. Furthermore in United Kingdom Idris El-Sharif, Dick Brown, Bruce Burton, Bill Nixon and Alex Russell analyzed that the oil and gas sector, utilizing informations refering to the United Kingdomn ( UK ) , the major oil manufacturer in the European Union ( EU ) . Their findings pointed out that the relationship, all the clip, is positive, frequently extremely important and reveals the direct impact of volatility in the monetary value of rough oil on equity values within the industry.

Additionally, Mcsweeney and Worthington ( 2007 ) examined the impact of macroeconomic hazard factors on Australian industry returns. Their research indicated that the macroeconomic factor specifically oil monetary values are of import determiners of extra returns for many industries. Of the nine industries considered, the energy industry exhibited a strong positive association with oil monetary value additions, while the banking, retailing and

Chapter 3: Research METHODS

Methods of Data Collection:

Secondary information has been collected to size up the relationship between macroeconomic variables and industry stock returns, monthly informations over the period July 2003 to June 2008 has been employed. The pick of a monthly frequence is consistent with old work which examines macroeconomic variables in relation to equity returns ( Faff and Brailsford ( 1999 ) , Sadorsky ( 2001 ) .

Sample Size

Monthly informations of industrial returns, rough oil monetary values, KSE 100 and foreign exchange rate has been collected for the period of 5 old ages since July 2003 to June 2008. Data has been gathered from State Bank of Pakistan ( SBP ) , Karachi Stock Exchange ( KSE ) and OGRA. Automobile and allied, Oil and Gas, Chemical and Pharmaceuticals sectors have been considered to analyze the impact of rough oil monetary value on their stock returns.

Research theoretical account

The cardinal enterprise of this analysis is to reason whether macroeconomic information, specifically rough oil monetary values, gives incremental information beyond the market portfolio refering the behaviour of industry stock returns. While at least some work has been conducted at the market degree ( Charles, Jones and Gautam, ( 1996 ) , and Antoniou, Garrett and Priestley, ( 1998 ) ) moderately few surveies have attempted to size up the relationship between macroeconomic factors and stock returns at the sector degree. To representation the relationship between the macroeconomic factors and industry returns, a multifactor theoretical account following Mcsweeney and Worthington ( 2007 ) , Faff and Brailsford ( 1999 ) , and Sadorsky ( 2001 ) is employed.

R it = I?i0+ I?i1 mkt +I?i2 oil +I?i3 fx + eit

where R it denotes the return on the stock index of the ith industry at clip T, mkt is the return on the market portfolio, oil is the alteration in oil monetary values, fx is the alteration in the exchange rate, I?i are parametric quantities to be estimated that are expected to change by industry, and eit is the error term.


Industrial Stock Returns.

Industrial stock return is the monthly output ( return ) on the monetary value of the stock of peculiar industry for a given clip ; the monetary values have of stocks have been taken from Karchi Stock Exchange. The stock return in each industry is calculated as:

rit =ln ( indi ; t/indi ; t-1 )

where, rit is the continuously compounded monthly return for industry I at clip T, indit and indi, t-1 are the index monetary values for industry I at clip T and T -1, severally.

Oil Monetary value

Oil monetary value is the per centum of oil monetary value alteration for a peculiar given clip period ( one month ) . The oil monetary value factor is constructed as:

oilt = ln ( wtxt/wtxt-1 )

Where, oilt is the log monthly alteration in the oil monetary value at clip T, and wtxt and wtxt-1 is the several monetary value of oil at clip T.

Exchange Rate

The exchange rate is the per centum alteration in foreign exchange ( PKR/USD ) rate for a given clip period ( one month ) . The exchange rate factor is constructed as:

fxt = { ln ( PKRt/USDt ) / ( PKRt-1/USDt-1 ) }

Where, fxt is the log monthly alteration in the PKR/USDt exchange rate at clip T, and

PKR/USDt-1 is the several PKR/USD exchange rate at clip T and clip t – 1

Market Returns.

The market stock return is the output ( return ) on KSE 100 index for one month period of clip. The market return on the market portfolio is calculated as:

mktt =ln ( aoiit/aoiit-1 )

Where, mktt is the continuously compounded monthly return for the sum market Index at clip T, aoiit and aoit-1 are the values for the market index at clip T and T -1, severally.

Statistical Technique

Multiple Linear arrested development technique was usage to mensurate the impact of rough oil monetary value alterations on industrial stock returns

Chapter 4: Consequence AND FINDINGS


In this survey rough oil monetary value, foreign exchange rate and KSE index as independent variable were used to foretell the fluctuation in industrial stock returns such as chemical and pharmaceutical sector, car and parts sector and energy sector of Pakistan consistent with the old survey of McSweeney and Worthingto ( 2007 ) .

Multiple additive arrested development analysis was used to analyse the impact of oil monetary value ( one month lagged monetary value ) on assorted industrial stock returns. Model drumhead shows that the arrested development has performed a great occupation of patterning industrial stocks returns for assorted industries. Adjusted R2 explains that about 50 % , 42 % and 49 % of the fluctuation in industrial stocks returns for chemical and pharmaceutical, car and parts and energy sectors severally is explained by the theoretical account. R is the multiple correlativity coefficients ; it shows the relationship between the independent variables and dependent variable. The values 2.436, 2.133, and 2.716 ( & gt ; 2.0 ) of Durbin Watson autocorrelation trial show that there is no autocorrelation which may act upon the theoretical account.

Model Summary



R Square

Adjusted R Square

Std. Mistake of the Estimate


Chemical & A ; pharmaceutical Sector







Automobile & A ; Parts Sector







Energy Sector







The ANOVA tabular array below shows a important value of F statistic, stand foring that utilizing these theoretical accounts are better than saying the mean. This tabular array elaborates that arrested development end product nowadayss information about the divergence accounted for by the theoretical account. While, residuary explains that information non explained by the theoretical account. The theoretical account with high regressed value shows that the major divergence explained in the dependant variable by the forecasters ( independent variables ) . The f trial is the arrested development mean square upon the residuary mean square. The important value of f trial is less than 0.05 for all three theoretical accounts. This indicates that a additive relationship occur between rough oil monetary value and industrial stock returns.



Sum of Squares


Mean Square



Chemical & A ; Pharmaceutical Sector


Arrested development













Automobile & A ; Parts Sector


Arrested development













Energy Sector


Arrested development













Table of Coefficients


Unstandardized Coefficients

Standardized Coefficients



Collinearity Statisticss


Std. Mistake




Chemical & A ; pharmaceutical Sector


Oil monetary value








KSE100 Index








Exchange Rate








Automobile & A ; Parts Sector


( Constant )





Oil monetary value








KSE100 Index








Exchange Rate








Energy Sector


Oil monetary value








KSE100 Index








Exchange Rate








The tolerance is known as the per centum of discrepancy in a given independent variable ( forecaster ) that can non be contributed by the other independent variables or forecasters. Therefore, the high tolerances 1.00, 1.00 and 0.934 of forecaster oil monetary value for chemical and pharmaceutical, car and energy sectors severally show that no discrepancy in a specified forecaster or independent variable can be explained as a consequence of the other forecasters. If the tolerance degree is near to 0, it can be said there is a greater multicollinearity and it will blow up the standard mistake of arrested development coefficient. A VIF higher than 2.0 is normally considered debatable, and the VIF in the tabular array is all less than 2.00.

Market theoretical accounts augmented by an oil monetary value, exchange rate and KSE 100 index factor are estimated with ordinary least squares over the period July 2003 to June 2008 for each of the three industries. The estimated coefficients, standard mistakes and p-values of the parametric quantities detailed in Equation ( 1 ) are presented in Table of coefficients. Model drumhead includes the R2, the adjusted R2 from a single-factor market theoretical account, and an F-test of the void hypothesis that all incline coefficients are jointly zero and its p-value.

The estimated theoretical accounts are all extremely important at the five-percent degree, as indicated by the F-statistics and associated P values. The values of R2 ranges between 0.647 ( Automobile & A ; Parts Sector ) and 0.709 ( Chemical & A ; Pharmaceutical Sector ) , bespeaking that between 65 and 70 per centum of the fluctuation in extra industry stock returns is accounted for by the theoretical accounts. Hence, the theoretical accounts appear to suit the informations comparatively good.

The changeless term in two ( Energy and Chemical and Pharmaceutical sector ) estimated theoretical accounts are undistinguished and it is important for car and parts sector. The statistical insignificance of the changeless term is consistent with old empirical surveies of stock returns and macroeconomic factors ( Faff and Brailsford ( 1999 ) , Sadorsky and Henriques ( 2001 ) ) .

In footings of the sensitiveness of Pakistani industry returns to the oil monetary value factor, the estimated coefficient ( in brackets ) is important in all three theoretical accounts ; Chemical & A ; Pharmaceutical ( 0.034 ) , Energy ( 0.042 ) and Automobile and Parts ( -0.094 ) sectors.

Excess returns in the car industry are positively related to the oil monetary value factor. A possible account for the ascertained positive consequence is the ability of the car sector to reassign the addition in cost due to increase in the monetary value of inputs ( oil monetary value ) to consumer by increasing the monetary value of vehicles. This can increase the returns of the sector.

Previous empirical grounds suggests that the association between exchange rates and stock returns is both state and industry particular. The estimated arrested developments indicated that the coefficients for the AUD/USD exchange rate are insignificant for all three sectors.

Hypothesiss Assessment Summary

The hypothesis of the survey was to place the alteration in oil monetary values has important of the industrial stock returns of car, chemical and pharmaceutical and energy sectors of Pakistan. This tabular array shows the statistical consequence about the rejection and credence of the hypotheses.

Table: Hypotheses Assessment Summary






Change in oil monetary values has significantly impact on the stock returns of Automobile and Parts sector of Pakistan




Change in oil monetary values has significantly impact on the stock returns Energy sector of Pakistan




Change in oil monetary values has significantly impact on the stock returns Chemical and Pharmaceutical sector of Pakistan



The hypothesis that alteration in oil monetary value has important impact of the stock returns of car and parts, energy, and Chemical and Pharmaceutical sectors have been accepted at 95 % assurance and sig. value of.000. It showed that alteration in rough oil monetary value significantly act upon the industrial stock return of all three industries. Further more, the beta coefficients of oil monetary value of three industries are non equal ( Automobile and Parts ( 0.094 ) , Energy ( 0.042 ) and Chemical and Pharmaceutical ( 0.034 ) ) showed that the impact of alteration in rough oil monetary value consequence otherwise on stock returns of these industries.

Chapter 5: Decision AND DISCUSION


This survey examined the impact of macroeconomic hazard factors on Pakistani industry stock returns. Multiple additive arrested developments indicates that macroeconomic factor is specially oil monetary values, of import determiners of extra returns for car, chemical and pharmaceutical and energy sectors of Pakistan. Of the three industries considered, all industry exhibited positive important association with oil monetary value additions. While the negative oil monetary value coefficient were expected for the car industry but the significantly positive coefficient for the car and portion industry is a surprising determination. We suggest that this is because of the ability of reassigning the cost load on the client of the industry as it seems to hold inelastic demand for cars in Pakistan. Furthermore the oil monetary value coefficient of all three sectors is about equal so the hypothesis that oil monetary value has different impact on the industries under survey stood non accepted.

Deductions and Restrictions

This survey helped assorted investors, direction and other research worker in analysing and detecting the behaviour stocks returns in assorted sectors against the fluctuation in rough oil monetary values. Research pupils should farther work on multifactor plus pricing theoretical account and analyze other macroeconomic variables that may act upon the stock returns. In this analysis the major issue faced was handiness of the informations.


This research was limited to the lone three sector of Karachi Stock Exchange of Pakistan. The informations were taken from July 2003 to June 2008 due to informations handiness restraint. It suggested that such type of survey should be carried out with a big sample size and in other states of Asia as good, as to hold comprehensive thought about oil monetary value fluctuations and stock returns. Furthermore, it besides suggested that other factors except 1s examined in this survey should be researched as to hold perfect thought about stock returns behavior. Besides that, this survey can besides be replicated in other developing states.



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