The link between Crude Oil and the Economy

A figure of recent surveies have found a nexus between motion in rough oil monetary values and stock monetary values. However, this research concentrates entirely on London Brent petroleum oil monetary values Index and Malayan stock market. The present survey hence investigates the relationship between the volatility of rough oil monetary value return and Industrial sector stock return volatility utilizing informations associating to Malayan stock market. The survey will find the correlativity between both variables and step how strong the relationship is. A certain figure of industrial stocks are used since this sector has close relation with the ingestion of oil monetary value. By finding the correlativity in the relationship between variables, the impact of the volatility of monetary value for both variables can be measured.

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Oil is so important in the international economic system that forecasts of economic growing are routinely qualified with the caution ( demand ) : provided there is no oil daze ( Adelman ( 1993 ) , p. 537 ) . Crude oil is the primary energy in the universe and it will the universe ‘s individual most of import beginning of energy for the foreseeable hereafter as oil demand will go on to turn strongly. The instability in rough oil monetary value has important impact to the economic system.

Crude oil monetary values behave much as any other trade good with broad monetary value swings in times of deficit or glut. The rough oil monetary value rhythm may widen over several old ages reacting to alterations in demand every bit good as OPEC and non-OPEC supply. In term of capital market, the fluctuation of rough oil monetary values can act upon the motion of stock monetary values particularly for the return of stock itself. With oil now above $ 50 many bargainers and investing experts are taking notice. The stock market already is. Oil has had a negative consequence on the market of all time since it went above $ 35 a barrel. Since so on yearss that oil has raised the stock market has dropped and on yearss that oil has fallen stocks have gone up.

It is frequently ascertained that stock monetary values tend to fluctuate with economic intelligence, and this observation is supported by empirical grounds demoing that macroeconomic variables have explanatory power for stock returns. Fama ( 1981, 1990 ) , Chen et Al. ( 1986 ) , Barro ( 1990 ) , Schwert ( 1990 ) and Ferson and Harvey ( 1991 ) have found that U.S. stock returns and its aggregative existent activity are correlated.

The importance of oil to single economic systems and the universe economic system is good known and is demonstrated by the events environing the Iraqi invasion of Kuwait in 1990. Evidence is provided by Malliaris and Urrutia ( 1995 ) , who document a strong negative portion monetary value reaction to the Persian Gulf crisis. Notably, the strongest effects were observed in markets in the Asian and Australian part.

Jones and Kaul ( 1996 ) have tested whether an oil monetary value factor constitutes a systematic influence in the finding of monetary values in the equity markets of the U.S. , Canada, Japan, and the U.K. Their findings indicate that oil monetary value alterations have a damaging consequence on end product and existent stock returns in all four states. Energy monetary values in general, and oil monetary values in peculiar, are likely to hold an of import possible impact on the costs of factor inputs for many companies. Specifically, we expect the potency for a negative oil monetary value sensitiveness to be greatest in industries with a comparatively high proportion of their costs devoted to oil-based inputs, such as Transport. However, the sensing of any impact ( either direct or indirect ) is complicated by the ability of houses to go through on their sensitiveness to oil monetary value alterations to clients through altering goods monetary values or by the extent to which houses hedge against oil monetary value hazard.

Problem Statement

The chief intent of this survey conducted is to look into the sensitiveness of Malayan stock market monetary value return particularly in industrial sector to an oil monetary value factor. This can be done by find the relationship between the volatility of rough oil monetary value return and Malayan stock market monetary value return. It is of import to mensurate the correlativity between both variables in order to see how strong the correlativity of rough oil monetary value return volatility can significantly act upon the stock market monetary values.

There are several sectors in Bursa Malaysia, which is plantation, trading/services, consumer merchandise, industrial, belongings, finance, building and other. But non all of these sectors have straight impact to the higher oil monetary values since some of the sectors produce a merchandise that have inelastic demand. The ground to take industrial sector is because it is expected to be more affected to lift of rough oil monetary values compare to other sector. This would happen both through higher production costs, which would be peculiarly terrible in the traditional fabrication and transit companies, every bit good as through the lag in demand. Subsequently, if the oil monetary value rise were deemed to be lasting, there would be adjustment costs entailed in altering the input mix, with permutation off from oil.

There has been a go oning involvement by research workers over recent old ages in the function and impact that oil and other energy beginnings have on fiscal markets and stock monetary values. Although the majority of the empirical research have studied the relation between oil monetary value alterations and economic activity, it is surprising that small research has been conducted on the relationship between oil monetary value dazes and fiscal markets. Besides, few surveies have examined the effects of oil dazes on the stock market and economic activity chiefly for a few industrialised states such as the United States, United Kingdom, Japan and Canada ( Lee and Jones ; Huang et al. , 1996 ; Sadorsky, 1999 ) .

Faff and Brailsford ( 1999 ) indicated that stock monetary value return are negatively ( positively ) impacted by rises ( falls ) in oil and gas monetary values in Australia. It is indicated that dazes to the oil monetary values would positively impact upon monetary values index but negatively impact on market index. El-Sharif et Al. ( 2004 ) look into the relationship between the monetary value of rough oil and equity values in the oil and gas sector in United Kingdom. The grounds indicates that the relationship is ever positive, frequently extremely important and reflects the direct impact of volatility in the monetary value of rough oil on portion values within the sector. Jones and Kaul ( 1996 ) use quarterly informations to prove whether the reaction of international stock markets to oil dazes can be justified by current and future alterations in existent hard currency flows and/or alterations in expected returns. Using a cash-flow dividend rating theoretical account they find that the reaction of Canadian and U.S. stock monetary values to oil monetary value dazes can be wholly accounted for by the impact of these dazes on existent hard currency flows.

1.3 Research Question

For the survey, a several inquiries had been developed sing to the relationship between the volatility of rough oil monetary value return and Malayan stock market monetary value return. Therefore, the research inquiries are:

What is the relationship between the volatility of rough oil monetary value return and Malayan Stock market monetary value return?

How strong the volatility of rough oil monetary value return have influence on the return of the stock?

How much the volatility of rough oil monetary value return influences Malayan stock market monetary value return in term of cause and consequence?

Aims

This survey emphasizes on the relationship between the volatility of rough oil monetary values and Malayan stock market monetary values. Therefore, three aims have been identified for this research. The aims of this survey are

To find the relationship and correlativity between the volatility of rough oil monetary value return and Malayan stock market monetary value return.

To mensurate the strength of the correlativity that exists in the additive relationship between the petroleum oil monetary value return and Malayan stock market monetary value return.

To look into the cause and consequence of the volatility of rough oil monetary value return to Malayan stock market monetary values.

Significant of the survey

This survey will supply and lend to bing literatures and it will besides supply some utile information and better understanding about the relationship between the volatility of rough oil monetary value return and Malayan stock market monetary value return. It will besides supply the grounds and empirical consequence from the past surveies that has already been done towards the relationship both variables. For finance and investing field, this survey can be utile as a guideline when make an investing or carry oning similar research related to the survey.

Scope of Research

The range would cover Malayan capital market which is Bursa Malaysia whereas deeply involved in the country of industrial sector. 30 stocks of industrial sector in Malayan capital market will be picked indiscriminately and the hebdomadal shutting monetary value informations for 10 old ages which from 1995 to 2005 will be used. While for rough oil monetary value, Brent petroleum oil monetary value index per barrel will be used. Price per barrel for 10 old ages which is besides from 1995 to 2005 will be used to compare the correlativity and volatility with the stock monetary value. Data of 10 old ages is choose in order to demo the fluctuation and volatility of the monetary value since during these old ages the economic state of affairs was traveling a period of roar and flop.

Definition of Terms/ Concept

Common stock

It is an equity instrument that is issued by a company to raise capital to finance concern. It is reflected by a certification bespeaking the figure of portions registered in the name of proprietor.

Crude oil

Crude oil is a naturally-occurring substance found trapped in certain stones below the Earth ‘s crust. It is a dark, gluey liquid which, scientifically talking, is classed as a hydrocarbon. This means, it is a compound incorporating merely H and C. Crude oil is extremely flammable and can be burned to make energy. Along with its sister hydrocarbon, natural gas, rough oil makes an first-class fuel.

Crude oil per barrel

Crude oil is measured in barrels. When petroleum oil foremost came into large-scale commercial usage in the United States in the nineteenth century, it was stored in wooden barrels. One barrel equals 42 US gallons, or 159 litres.

Stock Price

Stock monetary values reflect the investors ‘ sentiment about the current mentality of the company. The monetary value of stocks goes up if the lucks of corporations are positive. This is normally means the company has a path record of transcending the outlooks of the investors in term of gross revenues and net income growing. As a consequence, investors will set a premium on its portions.

Stock Monetary values Volatility

Raney ( 1986 ) define that, stock monetary values volatility can be thought of as the standard divergence of the clip cumulative frequence distribution of stock monetary value alterations. It is step of the mean magnitude of monetary value alterations for one or more stocks over some period of clip. Volatility is besides of import to investors in order to gauge the hereafters monetary value. Volatility is one estimation of the hazard of an single stock or group of stocks or portfolio.

1.8 Theoretical Model

List of variables related to research job

Independent variables: Crude oil monetary value

Dependent variables: Stock monetary value

Conventional Diagram ( Relationship Diagram )

Hypothesis:

For this survey, three hypotheses were developed and mentioned as follow:

Hypothesis 1

Holmium: There is no relationship exist between the volatility of rough oil monetary value return and Malayan stock market monetary value return

H1: There is relationship between the volatility of rough oil monetary value return and Malayan stock market monetary value return

Hypothesis 2

Holmium: The volatility of rough oil monetary value return will non significantly explicate the discrepancy in the Malayan stock monetary value return

H1: The volatility of rough oil monetary value return will significantly explicate the discrepancy in the Malayan stock monetary value return

Hypothesis 3

Holmium: There is no farmer causality between the volatility of rough oil monetary values return and Malayan stock market monetary value return

H1: There is granger causality between the volatility of rough oil monetary value return and Malayan stock market monetary value return

1.8.1 Data Collection

The informations are obtained from secondary informations which come from assorted beginnings such as diary, one-year study and articles. For stock monetary values and Brent oil monetary values index, the informations were collected from the database ( DataStream )

1.8.2 Sampling Procedure

30 stocks of industrial sector in Malayan capital market will be picked indiscriminately and the hebdomadal shutting monetary value informations for 10 old ages which from 1995 to 2005 will be used. While for rough oil monetary value, Brent oil monetary value index per barrel will be used. Price per barrel for 10 old ages which is besides from 1995 to 2005 will be used to compare the correlativity and volatility with the stock monetary value.

1.9 Restriction of the Study

1.9.1 Time restraint

The clip given to finish the whole survey was merely three months. Because of clip restriction, this survey is non including slowdown footings in order to acquire consequences. Due to this, there are several consequences is non satisfy in this survey and non similar with the old research. Therefore, in order to finish this whole survey in a good comprehensive status, this research merely focused on the of import facet merely. If more clip is provided, the survey will bring forth a better consequence.

1.9.2 The cost involved

Cost involved in geting the related information and information in this survey. The high cost besides involves in order finishing this survey from the beginning to the stoping research. The cost are such as printing and run offing the diary and articles, the cost of breaker the Internet for roll uping information

1.9.3 Other topics to be concentrated

This undertaking paper is one of the topics taken during the concluding semester of Bachelor of Business Administration ( Honors ) Finance in UiTM. There are other three topics who require clip and concentration besides this undertaking paper. Therefore, a full concentration and committedness is rather impossible to give in this survey.

1.10 Organization of Studies

Chapter 1: Background of the Study

This chapter will give a brief thought on the background of the research, aims of the research, job statement, important of the survey and the restrictions.

Chapter 2: Literature Reappraisal

This chapter has covered the past surveies or researches every bit good as articles reviews that have been done by past research workers on the related field topic.

The beginnings come from the diaries, articles and others

Chapter 3: Datas and Methodology

In this chapter, it will explicate on how the survey will take topographic point. It besides will depict the method used and hypothesis of the consequences. All the informations came from the assorted beginnings such as Datastream, Ebscohost and Proquest available at University of Technology MARA ( UiTM ) library Johor Branch.

Chapter 4: Determination of the Study

This chapter presents the findings and analysis conducted for the intent of this research. It reviews the analysis of informations and derives the hypothesis testing.

Chapter 5: Decision and Recommendations

This chapter will sum up all the consequences and appropriate recommendation besides suggested.

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