Sensitivity of Stock Market Indices to Oil Prices: Evidence from Manufacturing Sub-Sectors in Turkey

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1 Received: 21 May 2011; Acceped: 05 May UDC :665,6 (560) DOI: /PAN E Original scienific paper Ibrahim Halil Eksi Faculy of Economics and Adminisraive Sciences, Kilis 7 Aralik Universiy, Turkey ieksi@kilis.edu.r Mehme Senurk Deparmen of Foreign Trade, Vocaional High School, Kilis 7 Aralik Universiy, Turkey msenurk@kilis.edu.r H. Semih Yildirim School of Adminisraive Sudies, York Universiy, Canada yildirim@yorku.ca Sensiiviy of Sock Marke Indices o Oil Prices: Evidence from Manufacuring Sub-Secors in Turkey Summary: Crude oil price is a criical cos facor for manufacuring indusries ha are of vial imporance for economic growh. This sudy examines he relaionship beween crude oil prices and he indices of seven Turkish manufacuring sub-secors over he period 1997: :12. The error correcion model resuls reveal he long erm causaliy from crude oil prices o chemicalperoleum-plasic and basic meal sub-secors indicaing ha hese sub-secors are highly sensiive o crude oil prices. We find no causal relaionship for oher secor indices for shor or long ime periods. Key words: Crude oil prices, Manufacuring sub-secors, VAR. JEL: M21, O16, R11. Following he collapse of he Breon Woods sysem, oil price has become a criical facor for world economies. Since oil revenue is generally he bigges source of income for many oil exporing counries, high volailiy in energy markes can cause economic imbalances in hese counries. Same is also rue for oil imporers. Since many indusries depend on oil as inpu, an increase in oil prices can creae significan cos-push inflaion and higher unemploymen, and subsequenly lead o economic crises. Over he pas decade, he price of oil a respecive inernaional exchanges has been rising and showing a volaile rend. For example, he oil pricing benchmark such as Wes Texas Inermediae hi an all-ime high of $145 per barrel in June 2008, before falling o $30 per barrel in December Developing counries in paricular are severely affeced by hese price movemens as hey are heavily dependen on foreign energy resources. Because of he criical role oil prices play in modern economy, wild price swings in energy markes have been an issue of concern o economiss and policymakers. Accordingly, he recen public and academic aenion no only o energy prices, bu also o he volailiy a he energy markes is no surprising. The energy consiues he mos imporan and cosly indusrial inpu in developed and emerging economies. Furhermore, elasiciy of subsiuion beween energy and oher inpus is close o zero. Oil accouns for more han 40% of he global energy consumpion. Expensive oil would imply subsanial increases in he price of energy sources, leading o a negaive impac on compeiiveness in oday's highly globalized world. Alhough cos pressures are fel by all indusries, he manufacur-

2 464 Ibrahim Halil Eksi, Mehme Senurk and H. Semih Yildirim ing indusry is usually among he secors ha are hi mos by oil price hikes. An increase in energy coss can significanly reduce he compeiive advanage in manufacuring expors. The volailiy in energy prices can also affec sraegic invesmen decisions. Facing a greaer energy inpu uncerainy invesors, managers and policy makers can aler or pospone heir invesmen decisions. A he macro level, increase in oil prices may lead o balance of paymen deficis in counries ha are highly dependen on oil impors. High and volaile energy prices can produce negaive macroeconomic consequences including reduced oupu and employmen, increased inflaion, and in rare siuaions a full-blown economic crisis. This paper aemps o invesigae he impac of oil price changes on manufacuring sub-secors in he conex of an emerging marke. We know ha he growh capaciy and performance of an indusry is closely relaed o he inpu coss. Wheher he observed increase in oil prices disparaely affecs differen indusries is he ineres of our analysis. Crude oil can indirecly increase producion coss in he form of higher energy coss even in indusries where i is no used as a direc inpu. In his conex, we aemp o deermine wheher changes in oil prices give rise o change in Food-Beverage, Basic Meal, Chemical-Peroleum-Plasic, Texile-Leaher, Wood Paper Prining, Meal Producs Machinery, Non-meal Mineral Producs sub-secor performance a Isanbul Sock Exchange using co-inegraion and Granger causaliy es. Our sudy differs from previous sudies in several respecs. Firs of all, earlier research primarily focuses on he impac of oil price on macroeconomic facors. The effec of energy prices on sock marke is usually invesigaed for he overall marke or in erms of sock marke performance of individual oil companies. Furher, mos of he relaed sudies examine he developed economies, only a few sudies are concenraed on emerging markes. And he research on he impac of energy prices on Turkish marke is relaively scan 1. Finally, unlike mos sudies we use monhly daa in our esimaions which conain more informaion han quarerly and annual series. Our sudy conribues o he lieraure by furhering our undersanding of he relaionship beween energy prices and manufacuring secor performance in emerging markes, namely in Turkey. The res of he sudy is organized as follows. Secion 1 summarizes he previous sudies. Secion 2 presens our model, he esable hypoheses, and he daa used. Secion 3 discusses he empirical resuls while Secion 4 presens he conclusions. 1. Lieraure There is a considerable amoun of lieraure on energy economics. In mos of he relaed sudies, he main heme is he effec of oil price on macroeconomic variables (see, among ohers, Rebeca Jimenez Rodriguez and Marcelo Sanchez 2004, 2009; Nung Bwo Huang, M. J. Hwang, and Hsiao Ping Peng 2005; Iaroslav Baclajanschi e al. 2006; Sandrine Lardic and Valérie Mignon 2008; Jan P. A. M. Jacobs, Gerard H. 1 Two excepions are Mehme Eryigi (2009) who examines he impac of oil prices on financial, service, and indusrial firms and Orhan Torul and Emre C. Alper (2010) who sudy he effecs of domesic oil produc price changes on manufacuring sub-secors of Turkey.

3 Sensiiviy of Sock Marke Indices o Oil Prices: Evidence from Manufacuring Sub-Secors in Turkey 465 Kuper, and Dean P. van Soes 2009; Yazid Dissou 2010). A growing body of academic lieraure suggess ha oil price increases and volailiy dampens macroeconomic growh by raising inflaion and unemploymen and by depressing he value of financial and oher asses (Shimon Awerbuch and Sauer Raphael 2006). Several oher sudies invesigae oil price and sock marke relaionship. According o Syed A. Basher and Perry Sadorsky (2006), a rise in oil prices will ac as inflaion ax, which will (1) lead consumers o look for alernaive energy sources and (2) increase risk and uncerainy which adversely affec sock prices and reduce wealh. Using an inernaional muli-facor model ha allows for boh condiional and uncondiional risk facors, he auhors find srong evidence ha oil price risk impacs sock price reurns in emerging markes. Using vecor error correcion model, Isaac J. Miller and Ronald A. Rai (2009) examine he long-run relaionship beween he world price of crude oil and inernaional sock markes over he period January 1971 o March They find a clear long-run relaionship beween oil price and real sock prices for six OECD counries. Inuiively, his means ha sock marke prices increase as he oil price decreases or decrease as he oil price increases, over he long-run. El I. Sharif e al. (2005) invesigae he relaionship beween he price of crude oil and equiy values in he oil and gas secor using daa from he Unied Kingdom, he larges oil producer in he European Union. Their evidence indicaes ha he relaionship is always posiive, ofen highly significan and reflecs he direc impac of volailiy in he price of crude oil on share values wihin he secor. Alhough he impac of oil prices has been exensively examined in he conex of developed economies, sudies covering emerging economies are relaively scan. Eryigi (2009) examines he effecs of oil price changes on secor indices of Isanbul Sock Exchange and find ha oil price (in TL) changes have posiive effecs on Elecriciy, Wholesale and Reail Trade, Insurance, Holding, Invesmen, Wood, Paper and Prining, Basic Meal, Meal Producs and Machinery, and Non-meal and Mineral Producs indices (significan a 5% level); on Tourism, Food, Beverages, Chemical, Peroleum and Plasics, Texile and Leaher indices (significance a 10% level). He also finds ha oil price (USD) changes have a significan posiive effec on Wood, Paper & Prining, Insurance and Elecriciy sub-secor indices. On he oher hand, oil price (boh as TL and USD) changes do no have any significan effec on Transporaion, Banks, Leasing and Facoring and Real Esae Invesmen Trus indices. In a relaed sudy Torul and Alper (2010) repor ha while oil price increases do no significanly affec he Turkish manufacuring secor in aggregae erms, hey do impede he producion growh of several manufacuring sub-secors, including Wood and Wood Producs, Furniure, Chemicals and Chemical Producs, Elecrical Machinery, Radio, TV and Communicaion Apparaus, and Rubber and Plasic Producs. 2. Empirical Framework and Daa This sudy employs monhly ime series over he period January 1997 and November Subsecor index daa are obained from Isanbul Sock Exchange (ISE) while oil price daa come from Inernaional Energy Agency (IEA). We use he classificaion of manufacuring sub-secors by Isanbul Sock Exchange. Thus, seven sub-

4 466 Ibrahim Halil Eksi, Mehme Senurk and H. Semih Yildirim secors including Food-Beverage (FB), Basic Meal (BM), Chemical-Peroleum- Plasic (CPC), Texile-Leaher (TL), Wood-Paper-Prining (WPP), Meal Producs- Machinery (MPM) and Non-meal Mineral producs (NMP) were invesigaed. The graphical represenaion of crude oil prices during our sample period is presened in Figure 1. As shown in he graph, he oil prices moved wihin a relaively sable range of $12 o $30 per barrel beween 1997 and 2004, before aking an unprecedened ascen o all ime high price of $145 by July The price has dip below $40 per barrel again before he end of 2008 and followed an upward rend since hen Figure 1 Monhly Average Oil Price Daa (US Dollar) Source: Prepared by auhors using daa obained from IEA. Economic and financial ime series are ofen subjec o a recurring seasonal paern ha obscures heir underlying behaviour and rends. These inra-year periodic variaions make i difficul o analyze wheher he changes in daa for a specified period reflec increases or decreases in he level of he daa, or oherwise due o recurring variaion. Seasonal adjusmen is he process of esimaing and removing seasonal effecs from a ime series. In his sudy we employed Census X-12 ARIMA program developed by he U.S. Bureau of he Census for seasonal adjusmen of ime series. 2.1 Empirical Model and Tesable Hypoheses Considering he criical role energy prices play on he manufacuring firms, he goal of his sudy is o deermine he relaionship beween oil prices and manufacuring sub-secor indexes using co-inegraion analyses. The hypohesis being esed is oil prices significanly affec manufacuring secor indexes. Subsequen o esablishing he relaion beween hese variables, he hypohesis of he direcion of causaive

5 Sensiiviy of Sock Marke Indices o Oil Prices: Evidence from Manufacuring Sub-Secors in Turkey 467 relaionship is from oil prices o secor indexes will be esed. This poenial relaionship can be denoed by he following equaion: LSI lop u, (1) i where LSI is he logarihmic value of secor index i a monh ; LOP is he logarihmic value of oil prices in US$, and u is he error erm. In order o conduc a co-inegraion analysis we need o es wheher ime series involved are uni roo processes. The naural logarihms of he variables are aken o mainain saionary in ime series. Augmened Dickey-Fuller (ADF) and Phillips-Perron (PP) ess are used o es for he presence of uni roos in daa. ADF and PP uni roo es resuls reveal ha he ime series are no saionary. Following he uni-roo es, VAR model is employed and opimal lag lenghs are deermined by Schwarz Crieria (SC). We employ Soren Johansen s (1988) co-inegraion procedure o examine he exisence of a long-erm relaionship beween he ime-series. Finally, Granger causaliy es is performed o deermine causaliy relaion beween manufacuring subsecor indexes and oil price. 2.2 Uni Roo Tess Tesing for a uni roo is an essenial par of any ime series analysis. When a series has a uni roo, i is non-saionary, indicaing ha he mean and variance are changing over ime. In his paper we employed wo mos widely used uni roo es, namely Augmened Dickey Fuller (ADF) and Phillips and Peron (PP) ess. In Dickey-Fuller (ADF) es saionariy of he series was esed according o he following equaion: where Y is he variable subjec o saionariy es, Δ is he firs difference operaor and ε is he error erm. The null and alernaive hypoheses are H 0 : α 1 = 0 and H 1 : α 1 < 0. If H 0 is rejeced hen Y is said o be saionary. The Phillips Perron (PP) es uses he following equaion: y T ( ) y 1 v, (3) 2 where T is he number of observaions, (-T/2) is he ime rend and v is he error erm. The hypoheses esed are (H 0 : ρ=1) and (H 1 : ρ<1). If H 0 is rejeced hen y is saionary wih a deerminisic rend. 2.3 Coinegraion Tes k i 1 Coinegraion refers o a long-run relaionship beween non-saionary series. Rober F. Engle and Clive W. J. Granger (1987) indicae ha linear combinaions of wo or more nonsaionary series may be saionary. The exisence of a coinegraion relaionship in such linear combinaion suggess ha hese variables share a common rend and end o move ogeher in he long run. We used he vecor auoregression i i (2)

6 468 Ibrahim Halil Eksi, Mehme Senurk and H. Semih Yildirim model (VAR) proposed by Engle and Granger (1987) and Johansen (1988) o invesigae such relaionship. P h order VAR model is represened by he following equaion: y Ay... A y Bx 1 1 p p, (4) where y is a vecor of non-saionary variables, x is a vecor of deerminisic variables and ε represens error erms. VAR model in marix noaion is given by: p 1 (5) 1 i 1 i i. y y y Bx In his equaion, i is defined as: p A and 1 i i i I p A. j i 1 j (6) The coefficien of П shows ha if he reduced rank (r) is smaller han he number of endogenous variables (if r < k), hen П=αβ and β y is I(0) and here exis kxr number of α and β marices. r shows he number of coinegraion relaionship and each column of β is he coinegraion vecor. In our sudy, race es saisic is used for esing he coinegraion relaionship in number r. In his es H 0 invesigaes r and H 1 invesigaes k number of coinegraion relaionship (k is he number of endogenous variables). Trace saisic is calculaed as follows (Johansen and Juselius 1990, p. 170): LR where λ i is he i h eigen value of П marix. 2.4 Vecor Error Correcion Model r k i r 1 ( r / k ) T log(1 ), (7) Once we deermine he exisence of a long-erm relaionship beween wo series, we can examine he direcion of causaliy beween hem. Exisence of a relaionship beween wo variables in an economeric model does no necessarily mean a causaive relaion beween he same variables. Alhough he lieraure offers several approaches o deermine he direcion of exisen relaionship, his sudy employs Granger causaliy es due o useful inferences from is resuls and ease of applicabiliy. When ime series are coinegraed, sandard Granger causaliy es is no valid. In his case Vecor Error Correcion Model (VECM) insead of Vecor Auoregressive Model (VAR) is used o examine he causaliy relaionship (Granger 1988, pp ). Error correcion parameer in he model keeps he dynamics of he model in equilibrium and forces he variables closer o heir long erm equilibrium values. Saisically significan coefficien on he error-correcion parameer is a sign of deviaion from he equilibrium. The magniude of he coefficien represens he speed of error correcion mechanism. I is expeced o be significanly negaive. A larger value represens a faser convergence oward a long-erm equilibrium in cases of shor-run deviaions from equilibrium. While a significan error correcion erm is a sign of i

7 Sensiiviy of Sock Marke Indices o Oil Prices: Evidence from Manufacuring Sub-Secors in Turkey 469 long-erm Granger causaliy, significan F-Wald es saisic shows he exisence of a shor-erm causaliy. Vecor error correcion mechanism (VECM) for causaliy analysis beween x and y can be expressed as: Y m n r 1 1i Y 1 1i X i i 1 i 1 i 1 1i ECM r, 1 u (8) X m n r 2 2i X 1 2 i Y i 2i i 1 i 1 i 1 ECM r, 1 u The source of causaliy could be deermined by applying he -es o ECM. (9) 2.5 Granger Causaliy Granger causaliy es is one of he mos widely used approaches o deermine he direcion of relaionship beween variables. This es can be represened by he following wo equaions: Y p q 0 iy i i X i (10) i i 1 i 1 X p q 0 i X i iy 1 (11) i 1 i 1 where α and β are consan erms,, δ, π and λ are opimal lag lenghs for series X and Y. In hese models we es (δ 1 = δ 2 = = δ i = 0; λ 1 = λ 2 = = λ 1 = 0). Rejecion of his hypohesis in equaion 10 by F-es means X Granger causes Y; rejecion of he same hypohesis in equaion 11 means Y Granger causes X. The definiions of he variables used in our model are summarized in Table 1. Table 1 Noaions Used in Analyses LOP LOP Oil Prices LFB LFB Food-Beverage LBM LBM Basic Meal LCPP LCPP Chemical-Peroleum-Plasic LTL LTL Texile-Leaher LWPP LWPP Wood-Paper-Prining LMPM LMPM Meal Producs-Machinery LNMP LNMP Non-Meal Mineral Producs Noes: - Firs Log; L - Logarimic Values. Source: Auhors.

8 470 Ibrahim Halil Eksi, Mehme Senurk and H. Semih Yildirim 3. Resuls of he Simulaions Table 2 presens he resuls of he uni roo ess. Boh ADF and PP es resuls indicae ha all series of sample variables are no saionary in levels bu saionary in firs differences. Once we deermine he series as I(1), we employ Johansen s coinegraion procedure in order o gauge ou he presence of coinegraion vecors. Consequenly, VAR model is buil and opimal lag lenghs are deermined by SC. According o es resuls, he lag number for Food-Beverage, Basic Meal, and Chemical-Peroleum-Plasic, Wood-Paper-Prining and Non-Meal Mineral Producs Secors is 1, and for Texile-Leaher and Meal Producs-Machinery indusries are 2. The co-inegraion analysis was performed using hese lag numbers. Table 2 Resuls of Uni Roo Tes PANEL A: ADF TEST Variables Level 1 s Difference 1% 5% 10% ADF Tes 1% 5% 10% ADF Tes OP Inercep * Trend and inercep * FB Inercep * Trend and inercep * BM Inercep * Trend and inercep * CPP Inercep * Trend and inercep * TL Inercep * Trend and inercep * WPP Inercep * Trend and inercep * MPM Inercep * Trend and inercep * NMP Inercep * Trend and inercep * Panel B: PP TEST Secor Level 1 s Difference 1% 5% 10% PP Tes 1% 5% 10% PP Tes OP Inercep * Trend and inercep * FB Inercep * Trend and inercep * BM Inercep * Trend and inercep * CPP Inercep * Trend and inercep * TL Inercep * Trend and inercep * WPP Inercep * Trend and inercep * MPM Inercep * Trend and inercep * NMP Inercep * Trend and inercep * Noes: * denoes significance a 1% criical level. Opimum lag lenghs are se according o SC for ADF, Newey-Wes mehod for PP. Source: Auhors esimaions.

9 Sensiiviy of Sock Marke Indices o Oil Prices: Evidence from Manufacuring Sub-Secors in Turkey 471 The resuls of coinegraion ess in Table 3 reveal he exisence of long erm vecor for Basic Meal, Chemical-Peroleum-Plasic and Non-Meal Mineral Producs sub-secors. The resuls can be inerpreed as he long-erm equilibrium relaionship beween oil prices and hese hree manufacuring subsecors for he period Table 3 Resuls of Coinegraion Tes Secor H0 H1 LAGS Sampling period: 1997: :11 Trend assumpion: Deerminisic linear rend Eigen value Trace saisic 0.05 Criical value Prob. OP FB BM CPP TL WPP MPM R 1 R= ** 1 R 1 R= ** 1 R 1 R= R 1 R= R 1 R= R 1 R= ** 1 R 1 R= Noes: Models were esimaed according o SC. ** denoes rejecion of he null hypohesis a he 5% level of significance. Source: Auhors esimaions. Engle and Granger (1987) show ha if wo series are individually I(1) and coinegraed, hen here would be a causal relaionship a leas in one direcion. We can convenienly use he Granger causaliy es o deec he long-run causaliy among he variables. In he curren sudy, he error erms for coinegraion rend of he specific secors are found o be in seady sae. Afer his analysis, wheher he VECM mechanism works for hese secors was esed. The resuls of VECM for he 3 secors are given in he Table 4.

10 472 Ibrahim Halil Eksi, Mehme Senurk and H. Semih Yildirim Table 4 The Resuls of VECM Basic Meal Chemical-Peroleum-Plasic Dependen variable: LBM Causaliy resuls Variable Prob. Coefficien Shor erm Long erm ECT ** LBM LBM LBM LOP No LOP LBM LOP LOP f-wald es Dependen variable: LCPP Causaliy resuls Variable Prob. Coefficien Shor erm Long erm ECT ** LCPP LCPP LCPP LCPP LOP No LOP LCPP LOP LOP LOP f-wald es Dependen variable: LNMP Causaliy resuls Variable Prob. Coefficien Shor erm Long erm Non-meal Mineral Producs ECT LNMP LNMP LNMP LNMP LOP LOP No No LOP f-wald es Noes: Opimal lag number is deermined according o he Schwarz (SC). ** denoes 5% significance level. Normaliy of he model used for VECM is esed wih Jarque-Bera es; auocorrelaion is esed wih LM es. Source: Auhors esimaions. For Non-Meal Mineral Producs subsecor, we canno find he long erm causaliy in he error correcion model. On he oher hand, he error correcion mechanism can be applied for Chemical-Peroleum-Plasic and Basic Meal sub-secors, and herefore, he long erm relaionship could be found. The F-Wald es measures

11 Sensiiviy of Sock Marke Indices o Oil Prices: Evidence from Manufacuring Sub-Secors in Turkey 473 he effec of he lags of independen variables on dependen variables and shows he shor erm causaliy. The es resuls exhibi no saisically significan relaionship, indicaing no shor erm causaliy beween secor indexes and crude oil prices. The sandard Granger causaliy ess for Food Beverage, Texile Leaher, Wood Paper Prining and Meal Producs Machine sub-secors do no yield significan resuls as shown in Table 5. Based on hese resuls we conclude ha crude oil prices do no have significan impac on hese index values. Table 5 The Resuls of Granger Causaliy Tes Null hypohesis LOP does no Granger Cause LFB LOP does no Granger Cause LTL LOP does no Granger Cause LWPP LOP does no Granger Cause LMPM Conclusion: Findings and Recommendaions Prob. Source: Auhors esimaions. The increased volailiy in energy markes in general and crude oil prices in paricular has raised he ineres in his issue among academicians and policymakers because of is significan impac on differen secors. Since crude oil prices is a major cos facor in manufacuring secor, companies can be severely affeced by volaile movemens in energy-dependen emerging counries. This sudy examines he sensiiviy of he sock marke indexes of seven Turkish sub-manufacuring secors on crude oil prices. The error correcion model resuls reveals he long erm causaliy from crude oil prices o chemical-peroleum-plasic and basic meal sub-secors indicaing ha hese sub-secors are highly sensiive o crude oil prices. This is no surprising since oil is a direc inpu in hese secors. There is no causal relaionship for oher secor indexes for shor or long ime periods. Imporan conclusions arise from our analyses. To he exen ha negaive impac of oil prices can be miigaed, firms in hese secors can inves and grow, conribuing o overall economic growh. Therefore availabiliy and he use of alernaive energy resources, especially for hese wo sub-secors, should be faciliaed. In addiion invesors in capial markes should carefully consider he long erm relaionship beween oil prices and heir ineresed secor before invesmen decisions. The recen sharp increases in energy prices underline he imporance of developing alernaive energy resources for all counries. Lacking he nuclear power faciliies and sufficien renewable energy infrasrucure, Turkey has a compeiive disadvanage in his area. Furhermore, Turkey is dependen on impored oil and gas o mee 97% of is energy needs. The need o finance large rade defici caused mainly by oil impors makes Turkey dependen on ofen volaile, shor-erm foreign invesmen. This siuaion creaes an unwarraned exernal financial and credi risk, leaving he economy vulnerable o desabilizing shifs in invesor confidence. In ligh of coninuing global economic urmoil, Turkey urgenly needs o develop policies ha address how o diversify is energy resources and increase he share of is renewable energy sources.

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