The Stock Market Reaction to Oil Price Changes
Sridhar Gogineni Division of Finance Michael F. Price College of Business University of Oklahoma Norman, OK 73019-0450
March 13, 2008
Abstract I explore the reaction of the stock market as a whole and of different industries to daily oil price changes. I find that the direction and magnitude of the market‟s reaction to oil price changes depend on the magnitude of the price changes. Oil price changes most likely caused by supply shocks have a negative impact while oil price changes most likely caused by shifts in aggregate demand have a positive impact on the same day market returns. In addition to the returns of oil-intensive industries, returns of industries that do not use oil to any significant extent are also sensitive to oil price changes. Finally, I show that both the cost-side dependence and demand-side dependence on oil are important in explaining the sensitivity of industry returns to oil price changes.
I am indebted to Louis Ederington. I am grateful for the helpful comments received from Chitru Fernando, Vahap Uysal, Cynthia Rogers, Carlos Lamarche, Shawn Ni, Vikas Raman, Veljko Fotak, Jesus Salas, Ginka Borisova and Anthony May. I also acknowledge support from the Center for Financial Studies and the Summer Research Paper support fund at the University of Oklahoma. All errors are my own.
21 September 2006. “Unchanged Rates, Oil-Price Dip Rally Stocks” 17 January 2007 “Dow Clears Another Record As Oil Prices Continue to Fall” 17 May 2007 “Industrials Push to New High on Deal Optimism, Oil‟s Fall” 19 October 2007 “Dow Slips and Dollar Slides As Oil Jumps, Job Claims Rise” (Headlines from The Wall Street Journal) As the above headlines illustrate, in the recent months the popular financial press has talked repeatedly about how oil price changes are impacting the stock market. In fact, during the years 2005 and 2006, oil prices figured in the headlines1 of The Wall Street Journal on 204 days and a majority of these attribute stock price movements the previous day to oil price changes. As reviewed below, a considerable economics literature has been devoted to study the long-term impact of oil prices on macroeconomic variables such as inflation, growth rates, and exchange rates. However, despite the attention oil prices receive on a regular basis, there is very little research in the finance literature on how the stock market reacts to oil price changes. While the financial media assumes that the stock market is strongly influenced by oil prices, no one has measured how strong the relation is and what factors influence this relation. Petroleum is an essential energy source in the US accounting for 40% of total energy requirements. In 2006, the total demand for oil in dollar terms was approximately $506 billion, which is equivalent to 3.8% of US GDP.2 Given the importance of oil, its short-term demand price inelasticity, and the attention oil prices receive in the financial press, an understanding of the impact of oil price changes on market returns is essential to market participants. In this paper, I investigate the impact of oil price changes on the stock market as a whole and on individual industries from a financial markets perspective.
The search terms used are “oil prices”, “oil price”, “oil prices and stocks” and “oil price and stocks”. US GDP in 2006 was $13.21 trillion. Average price per barrel and average demand were $66 and 21 million barrels per day in 2006. This is projected to increase to 28 million barrels per day by 2030. Sources: http://www.eia.doe.gov;http://www.cia.gov/library/publications/the-world-factbook/print/us.html
The first goal of the paper is to provide a systematic investigation of the impact of oil price changes on the US stock market. Using daily data from 1983 to 2006, I find that the overall relation between the stock market and daily oil price changes is weak, suggesting that the financial media...
Study Darby (1982)
Hamilton (1983) Golub (1983) Burbidge & Harrison (1984)
Chen, Roll & Ross (1986)
Gisser & Goodwin (1986)
Hooker (1996) Huang, Masulis & Stoll (1996)
Jones & Koul (1996)
Returns of market indices of several countries and Cash flows Weekly wage rates and proxies for human capital GDP, GDP deflator and federal funds rate
Keane & Prasad (1996) Bernanke, Gertler & Watson (1997)
1947 – 1996 1983 – 2000 1960 – 2001 1972 – 1988 1959 – 1997 1965 – 1995 1972 – 2001 1962 – 2000 1973 – 2002 1983 – 2004 1973 – 2003
Index of Industrial Production, interest rates & real stock returns Same as Huang, Masulis & Stoll (1996)
Barsky & Kilian (2001) Davis & Haltiwanger (2001) Lee & Ni (2002)
Hamilton & Herrera (2002)
Same as Bernanke et.al (1997)
Hong, Torous & Valkanov (2002) Hooker (2002) Pollet (2004)
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