OIL PRICE DYNAMICS AND STOCK MARKET RETURNS IN NIGERIA

Abstract

Stock market is a major source of finance for investors and firms. However, its ability to perform this role may be hindered by risk from Oil Price Dynamics (OPD) which makes stock returns uncertain. This risk is pronounced in Nigeria because derivative markets are still underdeveloped. The OPD either undervalues or overvalues the actual stock price and results in liquidity challenges to portfolio investors and firms. Sectoral analysis tends to unmask and pin-down the exact relationship between each sectoral‟s stock return and OPD. While existing studies have investigated the impact of OPD on Firms‟ Stock Returns (FSR) at aggregate level, little attention has been devoted to sectoral analysis. This study was, therefore, designed to investigate the effects of OPD on FSR at sectoral and aggregate levels in Nigeria. The Arbitrage Pricing Theory provided the framework. A Nonlinear Auto-Regressive Distributed Lag econometric model that captures OPD (positive and negative oil price change) was explored. Eleven sectors on the Nigerian Stock Exchange (NSE) were considered: Agriculture, Consumer Goods (CG), Construction, Finance, Oil & Gas (OG), Information and Communication Technologies (ICT), Conglomerates, Health, Services, Industrial and Natural Resources (NR). The OPD and other determinants of FSR (Exchange Rate-ER, World Market Risk-WMR, Lag of Firms‟ Stock Return-LFSR and Domestic Market Liquidity-DML) were explored. The FSR was measured by logarithm difference of two successive closing periods of stock price. Sectoral and aggregate models were estimated both in the short-run (SR) and long-run (LR) using daily data from January 6th, 2007 to December 31st, 2017. Data were obtained from Central Bank of Nigeria statistical bulletin, NSE annual report and Energy Information Administration annual energy outlook. All estimates were validated at α≤0.05. The SR estimates showed that positive OPD increased returns of financial (0.19; Pe=0.02) and conglomerates (0.10; Pe=0.05) sectors, but reduced that of CG (-0.04; Pe=0.02). When negative OPD decreased by 1%, it reduced stock returns of financial (-0.14; Pe=0.05), CG (-0.08; Pe=0.02), health (-0.06; Pe=0.03) and industrial (-0.05; Pe=0.02) sectors, but improved that of OG (0.06; Pe=0.02) sector in the SR. In the LR, when OPD increased by 1%, stock returns of OG (2.38; Pe=0.01), conglomerates (5.97; Pe=0.05), financial (3.837; Pe=0.00), CG (1.309; Pe=0.01) sectors gained values but that of construction lost (-2.94; Pe=0.04). The estimates also showed that 1% decrease in negative OPD led to reduction in returns of CG (-39.59; Pe=0.03), financial (-18.81; Pe=0.02), OG (-1.73; Pe=0.01), health (-0.29; Pe=0.01) sectors, while construction (2.46; Pe=0.04) and conglomerates (9.39; Pe=0.01) sectoral returns gained. In the aggregate, an increase in positive and negative OPD by 1% results in (-0.11; Pe=0.01)% and (-0.10; Pe=0.02)% reduction respectively in the stock returns of the NSE in the SR. In the LR, positive OPD improved returns by (5.13; Pe=0.04), while stocks lost value (-25.4; Pe=0.02) due to a percentage drop in negative OPD. Oil price dynamics had differential impact on sectoral stock returns in Nigeria. Thus, managers need to design better strategies to protect respective sectoral‟s returns from oil price shocks.