Oil Price Fluctuations and Firm Performance in an Emerging Market: Assessing Volatility and Asymmetric Effect

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1 Journal of Economics, Business and Managemen, Vol., No. 4, November 203 Oil Price Flucuaions and Firm Performance in an Emerging Marke: Assessing Volailiy and Asymmeric Effec Hawai Janor, Aisyah Abdul-Rahman, Ehsan Housseinidous, and Ruzia Abdul Rahim, Member, IACSIT Absrac This sudy examines he impac of oil price volailiy on firm performance in he conex of an emerging marke, Malaysia. The effec of crude oil price on he performance is examined for he period of January 986 o December 20 using GARCH and EGARCH models reflecing he evaluaion on volailiy and asymmeric effecs. Resuls indicae he significan effec of oil price volailiy on sock marke volailiy and also he asymmeric effecs. For policy makers, he findings help o clarify he dilemma of wheher he governmen should subsidize or oally depend on global oil prices in ensuring he susainabiliy and compeiiveness of Malaysian companies. In addiion, he resuls may assis businessmen in managing cos srucures in he even of rising oil prices in relaion o boh shor erm and long erm planning and provide invesors wih a beer picure of he exposure o oil price risks when invesing in Malaysian companies. producion, resuling in increased coss relaing o business operaions. Consequenly, higher business coss reduce cash flows, hus reducing sock prices. On he oher hand, rising oil prices also affec he discoun rae employed in he asse pricing formula in sock valuaion, since i is ofen used as an indicaor of inflaionary pressures. Despie he concepual developmen given by Huang e al. [2], many empirical sudies ha examine he relaionship beween oil flucuaions and sock reurns provide inconclusive evidence, among ohers Jones and Kaul [4], Huang e al. [2], Evangelia [5], Juncal and Fernando [6] and Mohany [7]. Hence, warrans furher sudies o be underaken on his opic. Index Terms Asymmeric effec, firm performance, oil price, volailiy. I. INTRODUCTION Sudying he impac of oil prices and performance in sock marke has been an acive and growing research area. The volaile world oil prices and oil prices in Malaysia (as depiced in Fig. and Fig. 2, respecively), alongside he ambiguous resuls of sudies on he impac of oil price variaions on marke performance have heighened research ineres in his area. Since he pioneering sudy of Hamilon [] on he impac of crude oil prices on US recessions, many sudies have examined he impac of oil price changes on macroeconomic variables. Besides affecing hese aggregae macroeconomic indicaors direcly, price of crude oil may also affecing firms performance hrough he effecs on operaional coss, and hus heir revenues. Hence, posiive crude oil price shocks would negaively affec he cash flows and marke values of companies. Since asse prices are regarded as he discouned value of fuure firms earnings or cash flows, hus such negaive effecs on firms performance would cause an immediae decline in he overall sock marke reurns (Huang e al. [2], Nandha and Faff [3]). According o Huang e al. [2], he rising oil prices, on one hand, in he absence of complee subsiuion affecs he facors of Manuscrip received March 4, 203, revised May 7, 203. This work was suppored in par by he Faculy of Economics and Managemen, Naional Universiy of Malaysia under Gran EP Hawai Janor is wih he Finance, Financial Services and Risk Managemen Deparmen, Faculy of Economics and Managemen, Naional Universiy of Malaysia, 43600, UKM Bangi, Selangor, Malaysia ( Aisyah Abdul Rahman and Ruzia Abdul Rahim are wih he Finance and Risk Managemen and Insurance Deparmen, Faculy of Economics and Managemen, Naional Universiy of Malaysia, 43600, UKM Bangi, Selangor, Malaysia ( Ehsan Housseinidous is wih he Faculy of Economics and Managemen, Naional Universiy of Malaysia, 43600, UKM Bangi, Selangor, Malaysia. Fig.. Trends of world oil prices from January 980 o A srand of lieraure relaed o oil prices focuses on he effec of oil price volailiy on he volailiy of sock markes (Arouri, Lahiani and Nguyen [8] and Masih, Peers & De Mello [9]. While he general impacs of oil price volailiy on economic and sock markes remains o be demonsraed, an analysis of he impac of oil price volailiy on he volailiy of sock reurns in emerging marke such as Malaysia, is worh conducing for wo principal reasons. Firsly, given ha he impac of oil prices is profound paricularly in developmen and srucure of financial markes in developed economies and emerging markes, make i imperaive o invesigae he impac of oil price volailiy on sock reurns in Malaysia. Undersanding he issue on Malaysia is poenially beneficial, as i is likely o exhibi characerisics differen from hose observed in well-documened developed markes. Secondly, given he fac ha Malaysia is a ne oil exporer, he analysis of Malaysia is a worhwhile examinaion, since several sudies have argued ha he effec of oil prices on he economy depends on wheher he economy is a ne oil imporer or ne oil exporer. For he ne oil imporer, an increase in oil prices may have a negaive impac on is expors as i increases producion coss. However, he impac can also be posiive if he poenial DOI: /JOEBM.203.V

2 Journal of Economics, Business and Managemen, Vol., No. 4, November 203 oupu level and acual oupu level have no reached a hreshold level a which oil prices can negaively impac oupu oil marke as more inensive use of energy han advanced economies mainly because of he greaer efficiency achieved. Similar srong reacion of sock reurns on oil price changes have been documened by sudies such as Evangelia [5], Masih e al. [9] and Mohany e al. [7] bu only parial evidence has been documened by Jones and Kaul [4] who find ha he reacion of Canadian and US sock prices o oil price shocks can be compleely accouned for by he impac of hese shocks on real cash flows bu no fully accouned for Japan and he UK. TABLE I: MALAYSIA S OIL PRODUCTION AND EXPORTS Fig. 2. Trends of oil prices in Malaysia from January 99 o (Jayaraman and Choong [0]). On he oher hand, for he ne oil exporer, he increase in COP may conribue o improvemen in erms of rade and increases in expor earnings. Since many sudies have focused on ne oil imporing counries, i is imporan o examine he issue in he Malaysian sock marke. Table I highlighs he increasing rend of he producion and ne expors of peroleum for Malaysia. For he expors, he rend is increasing since 98 and similarly for he oil producion. In 2008, oal oil producion amouned o no less han 728 housand barrels per day, increasing from he previous year figure. Given ha he presence of asymmeric effecs phenomenon is found wihin several sudies invesigaing he impac of oil prices on sock reurns (Basher and Sadorsky [], Mohany e al. [7]) hus, sudies ha considers such phenomena provide more insighs on he relaionship beween he wo variables. Hence, wih a specific focus on he Malaysian marke, he objecive of his sudy is o examine he impac of oil price on sock reurns which akes ino consideraion volailiy and asymmeric effecs. The paper proceeds as follows. The remaining secions consis of a lieraure review, a summary of he research mehodology employed, and he resuls of he analyses, followed by he final secion, which presens he conclusions. II. LITERATURE REVIEW A large body of lieraure has examined he impac of oil price changes on sock reurns; however he evidence has been mixed. Huang e al. [2] and Juncal and Fernando [6] find ha he reurn generaed by oil prices have no impac on sock indices and here is no gain in considering he risk caused by flucuaing oil prices on sock markes. In conras, Basher and Sadorsky [] find robus evidence ha he risks associaed wih changes in oil prices impac he performance of sock markes reflecing srong evidence of impac of oil prices on sock reurns. They poined ou ha he resuls show ha emerging counries are subjec o greaer influence in he The RON92 has been phased ou from he Malaysian perol marke since he official launch of RON95 perol on Sepember, 2009, wih a price ag of RM.80/lier, Several monhs before he official launching of he RON95, he price of RON92 was RM.75. Peroleum (Thousand Barrels per Day) Daa year hisory Malaysia Malaysia Toal Oil Producion Crude Oil Producion Ne Expors/Impors(-) F 80 Source: Energy Informaion Adminisraion (EIA) Inernaional Energy Annual For Creece marke, Evangelia [5] finds ha oil price shocks have an effec on he indusrial producion index. In conras, Juncal and Fernando [6] reveal ha here is no co-inegraing long-erm relaionship beween oil prices and indusrial producion index for European counries. However, heir sudy does no consider wheher he volailiy of he oil marke influences indusrial producion index. On he aspec of volailiy, Hamilon [2] saes ha urbulence in oil prices causes he marginal effec of any given oil price change o be reduced, herefore, asymmery migh no exis when accouning for oil volailiy. However, Federer [3] claims ha par of he asymmeric relaionship beween oil price changes and oupu growh found in previous sudies can be explained by he economy s response o oil price volailiy. On he oher hand, Sadorsky [4] finds ha eiher an oil price change or is volailiy has an impac on real sock reurns. On he issue of volailiy, Arouri e al. [8] examine Gulf Cooperaion Council (GCC) counries over he period and Masih e al. [9] on Korean marke provide suppor on he imporance of volailiy in esing he relaionship beween he wo variables. Also using daa on GCC in examining impac of oil prices changes on sock reurns from June 2005 o December 2009, Mohany e al. [7] find ha excep for Kuwai, sock reurn for oher five GCC counries reac posiively o changes in oil prices. Thus, a decline in oil prices has negaive impac on sock reurns and an increase in oil price has posiive impac. Their resuls 386

3 Journal of Economics, Business and Managemen, Vol., No. 4, November 203 suppor previous sudies which sugges ha emerging sock markes operae under a differen se of marke forces, compeiive environmens and governmen regulaions. Lieraures on he effec of oil prices has also found asymmeric effecs in which boh oil price hikes and falls are likely o have differen effecs on he sock markes (Basher and Sadorsky [], Sadorsky [4]). Oil price hikes have a negaive impac on sock reurns bu drops in oil prices do no necessarily have a posiive impac. However sudies such as Park and Rai [5] and Nandha and Faff [3] do no find evidence on asymmeric effecs in sock markes. Some explanaions regarding he asymmery puzzle come from invesmen uncerainy or secoral shif channels. Uncerainy abou energy prices may induce firms o pospone invesmen decisions, because of he uncerainy abou fuure invesmen climae (Bernanke [6] where as he secoral shifs view suggess ha unemploymen is, in par, he resul of resources being reallocaed from declining o expanding secors of he economy. In addiion, Ferderer [3] saes ha if oil price changes affec posiively oil price volailiy and if oil price volailiy has a negaive effec on he economy, hen hose explanaions have a poenial o explain he asymmery puzzle. III. METHODOLOGY AND DATA In his sudy, we examine he effec of oil price volailiy on he volailiy of Malaysian sock marke, one of he emerging markes in Asian region. We use Kuala Lumpur Composie Index (KLCI) o measure sock reurns and monhly reurns of he world crude oil price (COP) derived from Wes Texas Inermediae (WTI) for oil prices, due o he fac ha i is mos widely used indices in he world and used widely by previous sudies. Moreover, Juncal and Fernando [6] sae ha mos sudies involving oil price issues uilize world crude oil prices quoed in USD. The monhly daa used in his sudy are colleced from Thompson-Reuers Daa Sream. The sudy period spans from Jan-986 o Dec-20. The reurn on KLCI is compued by equaion (): R P P where, R represens reurn a ime, and P and P - represen value of index a he curren period and previous period respecively. In order o examine he volailiy, we employ he Exponenial Generalized Auoregressive Condiional Heeroscedasiciy (EGARCH) model. We es for uni roo of boh variables, employing he augmened Dickey-Fuller (ADF) and Zivo-Andrews (ZA) [7]. ZA uni roo es is used o es for robusness due o i. he resuls from ADF esing can be misleading when he ime series daa have srucural break or level shif characerisics, ii. ZA es is capable of capuring he breakpoin(s) in he ime series, as well as checking wheher he ime series is saionary or nonsaionary, even in insances involving he presence of a srucural break. Nex, in order o idenify he rue disribuion funcion for he error erms disribuion, he kernel densiy funcion is employed. Afer univariae framework, esing for he exisence of he volailiy marke () will be invesigaed by employing he EGARCH model. Resuls of his sep will show wheher here is asymmery effec (or leverage effec) in he KLCI daa generaing process. Nex, based on mulivariae framework, COP will be included in he EGARCH model in order o deec he magniude of volailiy. Hence, if he magniude increases afer he inclusion of COP, we can infer ha he volailiy of KLCI is increased as a resul of oil price volailiy. In he EGARCH model, which is empowered o capure he asymmeric effec of he financial markes, he increase in he volailiy no only provides evidence concerning he negaive impac of oil price volailiy on he KLCI, bu also provides informaion concerning wheher negaive oil price shocks have more significan impacs on his marke han posiive oil price shocks of he same magniude. A. Uni roo es The ADF ess he null hypohesis ha a ime series is I() agains he alernaive ha is I(0), assuming ha he dynamics in he daa have an Auoregressive Moving Average srucure (ARMA). One of he limiaions of ADF is heir inaenion o he presence or absence of break a series under consideraion. ZA suggesed a procedure o check wheher or no a series is saionary by he inclusion of break a series, allowing for he breakpoin, if i exiss using dummy variables o capure he break B. GARCH and EGARCH Models Bollerslev [8] inroduces he GARCH model, a condiional variance srucure ha follows he auoregressive form of condiional variance of he previous periods, as well as squared form of error erm. The model is represened by equaion (2): log q p j j i i j i u where condiional variance of u a ime depends no only on he squared error erm in he previous period, bu also depends on is condiional variance in he previous periods. The EGARCH model by Nelson [9], proposed asymmeric effecs exis beween posiive and negaive asse reurns. The specificaion for condiional variance is represened in equaion (3), as follows: (2) p 2 r q i k log 2 i k j j (3) i i k k j where k sands for capuring he asymmeric behavior of an asse reurn. EGARCH is capable of capuring he mos imporan sylized feaures of sock reurn volailiy, namely volailiy clusering, negaive correlaion wih reurn, logarihm normaliy and, under cerain specificaions, long memory. In addiion, i is able o capure he leverage effec, as repored by Black and Fischer (976), and indicaing ha shocks (i.e. bad news) have differen influence. Essenially, he EGARCH model can deermine wheher he impac of a negaive shock or bad news on he volailiy of an asse reurn is higher han a posiive shock or good news wih he same magniude. Furhermore, he logarihm form of he condiional variance implies ha he leverage effec has an exponenial form, hence he variance is non-negaive. 387

4 Journal of Economics, Business and Managemen, Vol., No. 4, November 203 IV. RESULTS The descripive saisics of he KLCI and he rends on he reurns are depiced in Table II; Fig. 3 and Fig. 4 respecively. Fig. 3 shows ha here are upward and downward movemens of he KLCI flucuaions, implying ha he mean and variance of his series is no fixed during ime and he ime series is nonsaionary. Neverheless, he reurn series, as shown in Fig. 4, does no exhibi any rend and is flucuaions are around he origin line, indicaing a saionary process. However graphical inferences are no sufficien or reliable enough o reflec he saionariy level, hence robus ess hrough uni roo esing are required. The resuls for he ADF and ZA uni roo ess are provided in Table III which show ha he KLCI is nonsaionary a level, bu he compued reurn series is saionary. The -saisics is no significan, hus he null hypohesis of hese ess canno be acceped and he price series is nonsaionary. However, he -saisics of he reurn series is significan, indicaing ha he series is saionary. These findings are suppored by he resuls of he ZA uni roo es, confirming ha he price series is nonsaionary, while he reurn series is saionary, even wih he presence of srucural break in he ime series. Therefore, due o he saionariy of he reurn series, his series will be used in he modeling process. TABLE II: DESCRIPTIVE STATISTICS OF THE KLCI Kuala Lumpur Composie Index (KLCI) Mean Median Maximum Minimum Sd. Dev. Skewness Kurosis Number of Observaions Reurn on KLCI Mean Median Maximum Minimum Sd. Dev. Skewness Kurosis Number of Observaions Nex, he resuls of he kernel densiy funcion are depiced in Fig. 5, which includes he Normal disribuion funcion and he Suden s- disribuion funcion. As apparen from par A of his figure, he kernel densiy of Suden s- disribuion provides a fied plo wih he KLCI reurn ime series as compared o Normal disribuion. A similar procedure is repeaed in par B of his figure, which demonsraes he kernel densiy of he firs difference of COP. Therefore, for modeling purposes, Suden s- disribuion will be uilized. In summary, i is found ha KLCI and COP are nonsaionary, bu heir firs difference forms are found o be saionary processes. In addiion, he resuls of kernel densiy sugges ha he Suden s- disribuion would be he appropriae disribuion funcion for he error erm. KLCI 997-Nov Fig. 3. KLCI price index Fig. 4. Reurn on KLCI. TABLE III: RESULTS OF THE ADF AND ZA UNIT ROOT TESTS Variable s Tes on he level form ADF ZA Inercep Trend & Inercep Inercep Trend & Inercep KLCI Oil_Pric e Tes on he firs difference form ADF ZA KLCI Oil_Pric e Noes:,, denoe significance a he 0%, 5%, and % level respecively. From Table IV, values repored in he brackes represen sandard error of esimaion. The GARCH model indicae he esimaed coefficiens of he variance equaion are significan, hence he oil price ime series follows a GARCH(,) procedure, showing he evidence of volailiy clusering phenomenon exiss in his ime series. TABLE IV: RESULTS FOR VOLATILITY ON THE COP Mean Equaion C AR() MA() (0.0032) Variance Equaion C 8.62E-05 (6.05E-05) Reurn on KLCI (2477) (0.0637) (0.238) (0.0365) Table V presens he resuls for he univariae and mulivariae framework. The upper par shows he resuls on he mean equaion, while he lower par shows he resuls on he variance equaion. TABLE V: RESULTS FOR UNIVARIATE AND MULTIVARIATE MODELING OF KLCI Type of Mean Equaion model C AR() MA() Oil_Price Model (A) - - (0.0035) (0.0625) E-5 Model (B) - - (0.006) (0.000) Variance Equaion Model (A) (0.204) Model (B) (0.2030) (0.0937) (0.0947) (0.0299) (0.0299) (0.2) (0.07) Model (A) and (B) represens he resuls for univariae modeling of KLCI reurn and mulivariae modeling of KLCI reurn and COP respecively. The values repored in he 388

5 Journal of Economics, Business and Managemen, Vol., No. 4, November 203 brackes represen he sandard errors of esimaion. The EGARCH equaion, ( k ) capures he asymmeric characerisics of he ime series and he zero value of his coefficien represens he inexisence of asymmeric effecs in one marke. The negaive significan value of his coefficien demonsraes evidence on he exisence of an asymmeric effec in he marke and, herefore, bad news will be more volaile han good news of he same magniude Par A Par B Kernel of Time series Kernel of Suden s- Disribuion Kernel of Normal Disribuion Fig. 5. Resuls of Kernel densiy. From model A, he significan resuls of he esimaed coefficiens of ( ) and ( ) demonsraes he exisence of volailiy clusering in he compued reurn series of KLCI. The resuls also show ha he coefficien ( ), which is uilized o capure he leverage effec, is significan, hus providing he evidence of asymmeric behavior of he Malaysian sock marke. Therefore, no only i is proven ha here is volailiy clusering in his marke, bu i is also demonsraed ha responses of his marke o negaive shocks and posiive shocks of he same magniude are differen, wih negaive shocks resuling in increased volailiy of he KLCI. The resuls from Model B demonsrae compued values for he coefficiens of ( ) and ( ) are significan, suggesing ha here is volailiy clusering in his model which is similar o he resuls from model A, and also he magniude of coefficien ( ) has increased o from in Model A. This finding implies ha he inclusion of oil price variable in he analysis has inensified he volailiy of KLCI reurn series daa. V. CONCLUSION Resuls of his sudy suppored previous sudies on he impac of oil price flucuaions on sock markes. The findings demonsrae ha oil price shocks, paricularly negaive shocks, inensified he volailiy of he KLCI and increased risks incurred hrough invesmen in his marke during such periods. In addiion, he exisence of asymmeric effecs on he impac of oil prices on sock reurns provide suppor o previous sudies ha claim rising oil prices end o have a greaer impac han price declines. The resuls provide useful informaion for managers in planning heir cos srucures in he even of increasing oil price; businessmen and financial managers o formulae shor erm, as well as long erm sraegies in relaion o financial managemen; risk managers in forecasing echniques o analyze he impac of oil price changes; policy makers and regulaors in decisions relaing o moneary and marke policies wihin Malaysia and invesors, as i depics heir poenial exposure o oil price risks when invesing in Malaysian companies. REFERENCES [] J. D. Hamilon, Oil and he macroeconomy since World War II," Journal of Poliical Economy, pp , April 983. [2] R. D. Huang, R. W. Masulis, and H. R. Soll, Energy shocks and financial markes. Journal of Fuures Markes, vol. 6, pp. -27, 996. [3] M. Nandha and R. Faff, Does oil move equiy prices? A global view, Energy Economics, vol. 30, pp , [4] C. M. Jones and G. Kaul, Oil and he sock markes, Journal of Finance, vol. 5, no. 2, pp , 996. [5] P. Evangelia, Oil price shocks, sock marke, economic aciviy and employmen in Greece, Energy Economics, vol. 23, pp , 200. [6] C. Juncal and P. G. Fernando, Do oil price shocks maer? Evidence for some European counries, Energy Economics, vol. 25, pp , [7] S. K. Mohany, M. Nandha, A. Q. Turkisani, and M. Y. Alaiani, Oil price movemens and sock marke reurns: Evidence from Gulf Cooperaion Council (GCC) counries, Global Finance Journal, vol. 22, pp , 20. [8] M. E. H Arouri, A. Lahiani, and D.K. Nguyen, Reurn and volailiy ransmission beween world oil prices and sock markes of he GCC counries, Economic Modeling, vol. 28, pp [9] R. Masih, S. Peers, and L. De Mello, Oil price volailiy and sock price flucuaions in an emerging marke: Evidence from Souh Korea, Energy Economics, vol. 33, pp , 20. [0] T. K. Jayaraman and C. K. Choong, Growh and oil price: A sudy of causal relaionships in small Pacific Island counries, Energy Policy, vol. 37, pp , 2009 [] S. A. Basher, and P. Sadorsky, Oil price risk and emerging sock markes, Global FinanceJournal, vol. 7, pp , [2] J. D. Hamilon, This is wha happened o oil price-macroeconomic relaionship, Journal of Moneary Economics, vol. 38, pp , 996. [3] J. Federer, Oil Price Volailiy and Macroeconomy, Journal of Macroeconomics, vol. 8, pp. -26, 996. [4] P. Sadorsky, Assessing he impac of oil prices on firms of differen sizes; i is ough being in he middle, in Energy Policy, pp [5] J. Park, and R. Rai, Oil price shocks and sock markes in he U.S. and 3 European counries, Energy Economics, vol. 30, pp , [6] B. S. Bernanke, Irreversibiliy, Uncerainy, and Cyclical Invesmen, Quarerly Journal of Economics, vol. 98, no., pp , February 083. [7] E. Zivo and K. Andrews, Furher evidence on he grea crash, he oil price shock, and he uni roo hypohesis, Journal of Business and Economic Saisics, vol. 0, no. 0, pp , 992. [8] T. Bollerslev, A Condiionally Heeroskedasic Time Series Model for Speculaive Prices and Raes of Reurn, The Review of Economics and Saisics, vol. 69, no. 3, pp , 987. [9] D. B. Nelson, Condiional heeroskedasiciy in asse reurns: a new approach, Economerica, vol. 59, no. 2, pp , March

6 Journal of Economics, Business and Managemen, Vol., No. 4, November 203 Hawai Janor earned her Ph.D (Finance) from Science Universiy of Malaysia, Maser in Finance (S Louis Universiy, Missouri and BSc in Business Sudies (Indiana Universiy, Bloomingon, Indiana, USA), an Associae Professor a he Naional Universiy of Malaysia. She has published and reviewed aricles for local and inernaional journals in he area of financial marke, financial services, inernaional finance and risk managemen. Aisyah Abdul-Rahman is currenly an Associae Professor a he Naional Universiy of Malaysia (UKM). Her research ineress are bank risk managemen, bank efficiency, financial economics and corporae finance. She has sudied in Lehigh Universiy, Pennsylvania, U.S ( ), Naional Universiy of Malaysia ( ). Ruzia Abdul Rahim aained her BS (Finance); MBA (Corp. Finance) from he Sae Universiy of New York and her PhD (Invesmen).from he Naional Universiy of Malaysia. She has published a number of aricles on iniial public offerings and capial srucure; currenly he Chief Edior of Jurnal Pengurusan, a Scopus indexed journal published by he UKM Publisher. Ehsan Hosseinidous is currenly doing his PhD a he Faculy of Economics and Managemen, naional universiy of Malaysia. He is familiar wih differen mehods of sock markes modeling and forecasing which includes arificial neural neworks, fuzzy logic and hybrid sysems. 390

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