Cause & effect relationshipt research paper qta -kashif ahmed saeed

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Issue 023(07)/2012 ISSN: XXXX-XXXX
Quantitative Technique in Analysis using Econometrics
1
An investigation of cause and effect relationship between oil and stock prices
Muhammad Imtiaz Subhani 1, Kashif Ahmed Saeed 2, Mohammad Zeeshan3,
Mohammad Obaid4, Yaqoot Zehra 5 Qurat-ul-ain6
1 Iqra University Research Center -IURC, Karachi- Pakistan
Abstract. The objective of this study is to investigate the cause and effect relationship
between oil and stock prices of Pakistan, United states and Kuwait. The present study
examines how rise in price of crude oil supplied for economic consumption in a country
effect to the stock prices similarly how rise in stock prices in a country impact to crude
oil prices and consumption, and what kind of relationship exists between oil and stock
prices. The study is done by taking last 05 years data available for Pakistan, United states
and Kuwait’s economic indicators. Results revealed that rise in oil prices impact in
directly proportion to stock prices of the country.
Key Words: oil prices, stock prices, inflation, Investment.

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1 Introduction
Trend of global business is changing the nature of entire financial system almost all major entities are
interlinked now like commodities, stock and forex all the said markets have now correlation that can be
used smart business geeks in forecasting, now a days stock prices are going sky high as its a general
perception that whenever oil prices increases US$ gets down gradually may be due to negative correlation
Stock and Oil prices are supposed to be the basic parameter in financial trading along with forex rates
which more or less work on the same mechanics,
Our research is based on causes of oil prices and their effects on stock prices and similarly causes of
stock prices and their effects on oil prices for the economy
Individual’s wellbeing is the top most priority for every democratic state. Economy of an individual is as
important as the economy as whole. Since the advent of human history, the individual needs, be it of any
kind, are always be the great interest of human being. A proper source of employment can help to rid-off
from this devastating situation. It is irrefutable that the world is continuously changing. The shift from
the feudal to industrial society and the due importance of finance, individual needs are raised to a visible
extent. In Pakistan, due to enormous rise in population, unemployment and resource constraints, the
individual finances have been badly affected in recent time.
Pakistan with a population of more than 150 million has been on the path of rising GDP growth in
the last couple of years, but since the last fiscal year the situation is not very sound. The continuous rise in
oil prices in the last few years is regarded as one of the contributory factor. Energy sector has a direct
link with the economic development of a country. In line with the rising growth rate of GDP, demand for
energy has also grown rapidly. The magnitude by which economies are hurt as a result of price shock
depends on the share of cost of oil in national income, the degree of dependence on imported oil and the
ability of end-users to reduce their consumption and switch away from oil. In the energy mix for the
year 2005-06, oil accounts for 32 percent of the total energy used in Pakistan. Although the intensity with
which oil is used in total energy consumption has declined in the last few years but still it is the second
largest source of energy used after natural gas, which accounts for 39 percent. As far as the energy

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intensity is concerned it has remained almost constant since 1990-91 (i.e., 1 %). Decrease in energy
intensity is considered as the most promising route for reducing vulnerability to oil shocks.
With oil being the second largest source of energy used along with almost a constant rate of its production
Pakistan is heavily dependent on oil imports from Middle East exporters (Saudi Arab playing the lead
role). Almost 82% of the demand for petroleum products in the country is met through imports2. Pakistan
spent about 44 percent of export earnings on oil imports in 2006-07. This percentage was only 27 percent
in 2004-05. Therefore, the international oil price fluctuations have a direct bearing on the macroeconomy
of the country, especially on the oil price GDP relationship. The share of net oil imports in GDP is an
index of the relative importance of the oil price rise to the economy in terms of the potential adjustments
needed to offset it.
The goal in this paper is to shed light on the nature of the impact of oil shocks on the macroeconomic
conditions of a country. This research will analyze the impact of oil price on the output growth of the
country along with the monetary policy function on the presumption that State Bank has pursued inflation
targeting and conducts monetary policy to maintain price stability and output growth. Secondly, this study
will examine the cause and effect relationship between oil prices and stock prices.
2 Monetary policy
Central banks are responsible to implement a country's chosen monetary policy. Establishing what form
of currency needs to be implemented in the country. This is the most basic level of activity by Central
Bank.
A central bank may also use help from another country as their currency either directly (in a currency
union), or indirectly (a currency board). In countries with fiat money, expression "monetary policy" may
mention more closely to the interest-rate targets and other active actions commenced by the monetary
authority.
Goals of Monetary Policy:

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 Price Stability: Unanticipated inflation leads to lender losses. Immaterial agreements attempt to
interpretation for inflation. Effort will be successful if monetary policy able to maintain steady
rate of inflation.
 High Employment: Frictional unemployment is refers to as the movement of workers between
jobs or workers swapping various jobs. Apart from frictional unemployment, other
unemployment is classified as unintended unemployment. By targeting macroeconomic policy,
reduction in his area can be achieved.
 Economic Growth: Economic growth is enhanced by conjecture in scientific developments in
production. Supporting savings supplies funds can be drawn upon for investment.
 Interest Rate Stability: Interest Rate Stability refers to as unstable attention and exchange rates
which generate costs to lenders and borrowers. This leads to unexpected changes which cause
impairment, making policy preparation difficult.
The monetary cause includes Money supply and Money demand.
If Money demand (Md) increase, the overall price (P) increase results in lower down the Investment (I)
and higher interest rate (r ) so the aggregate expenditures (AE) will go down causes the lower level of
output/Income.
3 Research Problem
Impact of oil prices to stock index prices and vice versa in economic growth, this study includes the
variable like GDP, Growth, Oil price, stock index and Interest rate.

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Literature Review
Akhtam,Maghyereh (2004) found dynamic linkages between crude oil price shocks and stock market
return in 22 emerging economies.
Oil prices plays a vital role in economy it’s a commodity which is supposed to be the energy engine of
economy. one would expect changes in oil prices to be correlated with changes in stock prices, it is to be
considered that where oil is the basic parameter of economic operation will definitely be affecting
revenue of organizations. Certainly oil prices will be inversely proportional to earnings of public stocks.
Akhtam utilizes general approach to forecast responses of growing oil prices based on current economic
factors.
AROURI ,Mohamed El Hédi (2010) highlighted that there are several passages by which oil prices may
affect stock market or forex prices. The most important of oil price changes as a factor affecting stock
market returns they infected stock returns. These cash-flows are affected by macroeconomic events that
possibly can be influenced by oil shocks. Oil price fluctuations may influence stock market facts and
figures. Past studies and experiences proves this relationship within the framework of using low
frequency (monthly or quarterly) data from oil importing countries. Using weekly data and nonlinear
models, Arouri investigates short-run relationship between oil price shocks and stock markets in the Gulf
Cooperation Council (GCC) countries, previous studies on the impact of oil price changes on GCC stock
markets are too heterogeneous to lead to general repercussions. These findings are confusing as the GCC
countries are strongly oil exporters and share several commonalities in their economic structures. The
conclusions of these studies could be due to the fact that the tests they rely on are not powerful enough to
detect linkages. Arouri contend that there are some confusing signs in the relationship between oil prices
and the economic activity.
4 Research Methodology
Cause-and-effect research methodology was used along with statistics through past data for exploring the
relationship among variables.

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First designed the data gathering method and then using SPSS software for analyzing the data for
reasonable conclusion and testing of hypothesis.
Research Hypothesis
H0: There is no effect of oil prices on stock prices
H1: There is effect of oil prices on stock prices
H2: Oil is not the cause of increase of stock prices
H3: Oil is the cause of increase of stock prices
4.1 Model
Oil_price Consumption Economic_growth Stock_Price
Oil_price Consumption Economic_growth Stock_Price
The Econometric Model would be as follows:
OilPrices = α + β1+Stock_Prices+ET
OR
Stock_Prices = α + β1 + Oil_Prices + ET
Since there were chances that oil prices cans cause stock prices to come down and stock prices may
effect to oil prices to reduce so we use both the test using Granger causality test to find the relation.

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4.2 Sample and Procedures
Last 05 years data of Pakistan, UAE and India
4.3 Data Collection
Data was collected through reliable economic sources by visiting official websites of economic surveys,
State Bank reports, IMF reports and others.
4.4 Hypothesis and Data Analysis
Data analysis is a procedure of scrutinizing, cleaning, transforming, and modeling data with the goal of
underlining useful information, suggesting conclusions, and supporting decision making. Data analysis
has several facets and methods, encompassing assorted techniques under a variety of names, in different
business, science, and social science domains.
The purpose of this paper to investigate cause and effect relationship between oil and stock prices, we
hereby propose below hypothesis for examination
H0: There is no effect of oil prices on stock prices
H1: There is effect of oil prices on stock prices
H2: Oil is not the cause of increase of stock prices
H3: Oil is the cause of increase of stock prices
For this aforesaid hypothesis, first we check the proposed model accuracy and result provide the result
that there is………………………………………….

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We conducted regression test on SPSS. At first, a time series data was collected and transformed the
independent variables into its previous lags. Significant outlier were found and in observation 26, 29,28
and 30 in depended variable which can create distort information so they were transformed.

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It was found that depended variable is only predicting from its current lag and current lag of investment.
There are no significant values determined for other independent variable like interest rate and
GDP/capita.
Inflation predicting from current lag of Investment

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Inflation effects from Investment
Regression was performed to determine whether the data is unbiased or not. The obtained Bi-lateral
Symmetric shaped curve [bell-shaped curve] indicates that the data is unbiased and normally distributed.
The result reveals about the underlying fact that there is BLUE during tradeoff between Inflation and
unemployment.

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Secondly, the result concluded that there is no-correlation exist between inflation and unemployment. It
was also observed by Dublin Watson value which is 2.013.
5 Conclusion
After analyzing the data we conclude our topic according to the above tests and techniques. The findings
of study have led to the result that there is………………………………………

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6 References
Akhtam,Maghyereh (2004).Oil Price Shocks And Emerging Stock Markets International.Journal of Applied
Econometrics and Quantitative Studies. Vol.1-2(2004)
AROURI, Mohamed El Hédi (2010).Oil Price Shocks and Stock Market Returns in Oil-Exporting
Countries.International Journal of Economics and Finance, Vol. 2, No. 5; November 2010
Website Reference
www.sbp.org.pk State Bank of Pakistan - The Central Bank.
www.imf.org IMF -- International Monetary Fund
http://www.opm.gov
http://notesforpakistan.blogspot.com/2009_08_25_archive.html
http://worldwidescience.org/topicpages/m/macroeconomic+risk+factors.html

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7 Annexure
Propose Model
Inflation= α + β leg Unemployment +β leg Inflation + β leg Interest rate +β leg Investment + β
leg GDP
Year
Inflation
(%)
Unemployment
Rate
Interest
Rate
(%)
Investment
(% of GDP)
Population
(Million)
GDP Per Capita
(Constant Price,
in Rupees)
1980 11.927 3.3 12.5 19.93 82.432 17,322.83
1981 11.949 3.5 12.8 18.49 84.87 17,974.53
1982 5.862 3.8 12.5 18.94 87.38 18,599.54
1983 6.446 3.9 13 18.49 89.89 19,305.73
1984 6.056 3.8 12.8 17.97 92.4 19,732.61
1985 5.564 3.8 13 17.99 94.93 20,664.90
1986 3.467 3.2 12.5 18.53 97.5 21,227.14
1987 4.692 3 12.5 18.97 100.09 22,012.06
1988 8.835 3.1 12 17.85 102.71 23,086.17
1989 7.882 3.1 12 18.79 105.35 23,624.03
1990 9.051 6.2 15 18.81 108.4 23,982.99
1991 12.628 4.7 14 18.81 110.8 24,743.23
1992 4.851 6 15 18.97 114.075 25,915.80
1993 9.825 5.9 14 20.12 117.02 25,581.35
1994 11.272 4.8 17 20.6 119.99 25,880.57
1995 13.022 5 15 19.45 122.985 26,503.39
1996 10.789 5.7 17 18.46 126 27,122.97
1997 11.803 5.8 20 18.85 129.035 26,753.68
1998 7.812 6 18 17.77 132.085 26,802.43
1999 5.736 5.9 16.5 17.76 135.125 27,158.37
2000 3.584 7 13 15.52 137.53 27,820.19
2001 4.41 6 13 17 140.36 27,767.53
2002 2.504 8 10 16.58 143.17 28,092.21
2003 3.102 8.26 8 16.75 146.75 28,738.97
2004 4.568 7.9 7.8 16.57 149.65 30,262.49
2005 9.276 8.3 7.8 19.08 152.53 31,968.95
2006 7.921 6.6 9 22.14 155.37 33,313.93

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Year
Inflation
(%)
Unemployment
Rate
Interest
Rate
(%)
Investment
(% of GDP)
Population
(Million)
GDP Per Capita
(Constant Price,
in Rupees)
2007 7.771 6.5 8.8 22.52 158.17 34,569.04
2008 11.998 5.6 10 22.05 160.97 34,523.78
2009 20.775 7.4 15 18.95 163.774 35,075.51
2010 11.73 6.2 14 16.57 166.578 36,137.73

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