Stock Prices, Exchange Rates, and Oil: Evidence from Middle East Oil-Exporting Countries.

Transcription

1 Sock Prices, Exchange Raes, and Oil: Evidence from Middle Eas Oil-Exporing Counries. by Mohamed Abdelaziz* Universiy of Essex Georgios Chorareas** Universiy of Ahens and Andrea Cipollini*** Universiy of Modena and Reggio Emilia This version: March 008 Absrac We consider he linkage beween sock prices and exchange raes in four Middle Eas emerging markes. The exising evidence on sock prices and exchange raes ypically relies on inroducion of a global marke index. On he conrary, we find ha for he counries of our sample oil prices emerge as he dominan facor in he above relaionship. When we focus on he exended sample we do no deec evidence of coinegraion beween sock prices and real exchange raes, or of coinegraion among sock prices, real exchange raes and oher exogenous variables such as he US sock price or he oil price. To address he possibiliy ha his finding may be due o he presence of regime shifs we, firs, divide he sample ino wo subperiods based on he oil price shock in March 999. The Johansen race saisics reveals evidence of coinegraion only for he second subsample, among sock prices, real exchange raes and oil prices in Egyp, Oman and Saudi Arabia, and beween sock prices and oil prices in Kuwai. Uilizing he full sample and including deerminisic dummies in he VECM we aemp o capure he regime shifs. The FIML esimaion resuls corroborae he finings from spliing he sample, indicaing ha he oil prices have a longrun posiive effec on sock marke in each counry. Readjusmen owards he long-run equilibrium in each sock marke occurs via oil price changes. Finally, we produce persisence profiles showing ha convergence o he long run equilibrium akes 7 and 4 monhs in Egyp and Saudi Arabia respecively, while i akes and 4 mohs in Oman and Kuwai. * (Corresponding Auhor) School of Accouning Finance and Managemen, Universiy of Essex, Wivenhoe Park, Colcheser, UK. [email protected] ** Deparmen of Economics, Universiy of Ahens, Ahens 0559, Greece. Phone: 30 (0) [email protected] ***Deparmen of Social Cogniive and Quaniaive Sciences, Universiy of Modena and Reggio Emilia, viale A. Allegri, 9, Reggio Emilia, Ialy. [email protected]

2 . Inroducion Given he increasing rend oward globalizaion in financial markes, a subsanial amoun of research has been devoed o he invesigaion of he correlaion of sock reurns across inernaional markes. Eun and Shim (989), Hamao e al. (990), and Bekaer and Harvey (996), among ohers, invesigae he dynamics of inernaional sock movemens, and find significan cross-marke ineracions. These empirical findings are of ineres for wo reasons. Firs, porfolio heory suggess ha if he sock reurns beween markes are less han perfecly correlaed, invesors should be able o reduce heir risk hrough inernaional diversificaion. If counries sock reurns are posiively relaed, however, i is possible o use he informaion in one marke o predic he movemen in he oher marke. Second, he emerging markes implemened policy and regulaory reforms in recen years o faciliae cross-border invesing. The expeced reurns from he invesmen in foreign socks are deermined by changes in local sock price and currency values. If he effec of exchange risk does no vanish in well-diversified porfolios, exposure o his risk should command a risk premium. Therefore, he ineracion beween currency value and sock price is an imporan deerminan of global invesmen reurns (e.g., Doong e. al., 005). Esablishing he relaionship beween sock prices and exchange raes is imporan for a number of reasons. Firs, he link beween hose wo markes may be used o predic he pah of he exchange rae. This can have implicaions for he abiliy of mulinaional corporaions o manage heir exposure o foreign conracs and he exchange rae hey face. Second, currency is more ofen being included as an asse in invesmen funds porfolio. Knowledge abou he link beween currency raes and oher asses in a porfolio is vial for he performance of he fund. The meanvariance approach o porfolio analysis suggess ha he expeced reurn depends on he variance of he porfolio. Therefore, an accurae esimae of he variabiliy of a given porfolio is needed. This, in urn, requires esimaes of he correlaion beween sock prices and exchange raes. Third, he undersanding of he sock price- exchange rae relaionship may prove helpful o foresee a crisis. Khalid and Kawai (003) as well as Io and Yuko (004) among ohers, claim ha he link beween he sock and currency markes conribued in he propagaion of he 997 Asian financial crisis. I is believed ha he sharp depreciaion of he Thai bah riggered depreciaion of he oher currencies in he region, which led o he collapse of he sock marke as well. Awareness abou such a relaionship beween he wo markes could enable prevenive measures before he spread of a crisis. Tradiional models of he open economy sugges ha a relaionship beween he sock marke performance and he exchange rae behaviour may exis. For insance, goods marke approaches (Dornbusch and Fischer, 980) sugges ha changes in exchange raes affec he compeiiveness of firms as flucuaions in exchange rae affec he value of he earnings as well as

3 he cos of is funds (as many companies borrow in foreign currencies o fund heir operaions and hence is sock price). A depreciaion of he local currency makes exporing goods aracive and leads o an increase in foreign demand and hence revenue for he firm and is value would appreciae and hence he sock prices. On he oher hand, an appreciaion of he local currency decreases/increases he exporing/imporing firms profis because i leads o a decrease in foreign demand of is producs (e.g., see Gavin, 989). Porfolio balance models provide an alernaive raional for he relaion beween exchange raes and sock prices, sressing he role of capial accoun ransacions. Blooming sock marke would arac capial flows from foreign invesors, which increase he demand for is currency. The reverse would happen in he case of falling sock prices where he invesors would ry o sell heir socks o avoid furher losses and would conver heir money ino foreign currency o move ou of he counry. Such a scenario would lead o local currency depreciaion. As a resul, rising (declining) sock prices would lead o an appreciaion (depreciaion) in exchange raes. Moreover, foreign invesmen in domesic equiies could increase over ime due o benefis of inernaional diversificaion ha foreign invesors would gain. Movemens in sock prices may influence exchange raes and money demand because invesors wealh and liquidiy demand could depend on he performance of he sock marke (Mishra, 004). The exising lieraure ypically uilises a wo-variable framework o invesigae he relaionship beween exchange raes and sock prices. A number of recen sudies, however, poins ou ha such a sysem can be incomplee because of he omission of an imporan variables. If ha is he case, inferences abou he long-run relaionship of variables and he causaliy srucure are invalid. Lukepohl (98) and more recenly Caporale and Piis (997) show ha he omied variable in he exended sysem is he only deermining facor for he sensiiviy of causaliy inference beween he variables of he incomplee sysem. The role of oil as an omied variable In his paper we use oil prices o he sysem because all of he sample counries are oil exporers. The impac of rising oil prices on sock marke and exchange raes will differen from imporer o exporer counries. In fuel imporers counries, he rise in world oil prices worsens he rade balance, leading o a higher curren accoun defici and a deerioraing ne foreign asse posiion. A he same ime, higher oil prices end o decrease privae disposable income and corporae profiabiliy, reducing domesic demand and sock prices; along wih a depreciaion of he exchange rae, his acs o bring he curren accoun back ino equilibrium over ime. The speed and oupu cos of adjusmen depends on facors such as he degree of rade openness, srucural flexibiliy, and cenral bank credibiliy, as well as he shock s expeced persisence and he speed 3

4 wih which i is allowed o feed hrough ino domesic fuel prices. Among oher hings, hese deermine he exen o which rising oil prices raise inflaionary pressures, necessiaing a moneary ighening ha could lead o a more pronounced slowing in growh. In fuel exporers (such as OPEC counries), he process works broadly in reverse: rade surpluses are offse by sronger growh and, over ime, real exchange rae appreciaion and sock prices increasing. Oil is he main produc in he mos of Middle Eas counries -especially in he Gulf areasuch as Kuwai, Oman and Saudi Arabia. We can say ha, wihou exaggeraion, he oil is he main produc ha hese counries expor o he world, so ha he oil price shocks have a crucial effec on he economy of hese counries. Kubarych (005) poins ou ha here are five major oil shocks since 70s, he firs one was in 973; he proximae cause was he Ocober War in he fall of 973, followed by he Arab boyco of counries judged o be supporing Israel agains Egyp. The second was in because Iranian revoluion and Iran Iraq war, in his period OPEC decided o exploi is pricing power afer a period of resrain by announcing a 5 percen price rise for 979. The hird was in corresponding o he Iraqi invasion in Kuwai and he firs Gulf war, which resuled o a subsanial price spike -wihin weeks of Augus 990, Saudi ligh crude oil had jumped from abou 5 dollar per barrel o over 33 dollar per barrel. The fourh was in afer OPEC meeing in March, in he wake of he Asian financial crisis and a pick-up of Iraqi oil sales under he Unied Naions oil for- food program, oil prices plummeed o $0 per barrel in lae 998. Then oil prices began o head sharply higher bu his ime, unlike he hree previous episodes, wihou any geopoliical rigger. Raher, global demand began o swell as he high-ech bubble encouraged a big invesmen boom in Norh America and Europe and as he Asian economies began o recover. OPEC was eiher unable or unwilling o mach increased demand by raising oupu. By he middle of 000, oil prices ripled. The las one was in 00 when USA invaded Iraq. We rea oil prices as endogenous variable raher han exogenous because he changes in spo oil prices may reflec shocks o oher pars of he economy ha creae an imbalance in oil supply and demand. Such oil price changes may simply be endogenous responses o oher kinds of srucural shocks -he fourh oil shock is an evidence of ha. Barsky and Kilian (004) sugges ha he oil shock was endogenous raher han exogenous because, producers rade off he immediae gains from abandoning he carel agains he presen value of he fuure carel rens foregone. This logic suggess ha, all else equal, unusually low real ineres raes as in he 970s should be conducive o he formaion of carels and ha high real ineres raes should be derimenal. Furhermore, he abiliy of carels o keep prices high will be procyclical if producers IMF s World Economic Oulook, April

5 are unable o ell wheher oher carel members are cheaing by exceeding heir producion quoa. More specifically, in imes of unexpecedly low demand, when prices fall below a rigger poin, carel members will choose o flood he marke wih heir oupu. The assumpion of imperfecly observable oupu is paricularly appealing for crude oil producers. Thus, srong economic expansions, all else equal, should srenghen oil carels and major recessions weaken hem. This model helps o explain he surplus producion of oil following he Asian crisis of as well as he apparen success of OPEC during , he urning poin for oil prices indeed occurred as he firs signs of a possible U.S. recession emerged in lae 000. Wihin weeks he oil price began o slip, and is fall acceleraed hroughou 00. Shorly hereafer, he New York Times referred o he prospec of a devasaing price war, as OPEC was unable o enforce is goal of a major cu in oil producion in he face of falling demand. This analysis does no deny he imporance of poliical effors aimed a srenghening or susaining he oil carel; raher, he poin is ha such aciviies unlike wars are no exogenous and ha he susainabiliy of carels will be deermined o an imporan exen by he macroeconomic environmen. We also consider he possible role of a global marke indicaor (he proxy we use is he US sock marke as Phylakis and Ravazzolo, 005) in he sysem which can be hrough of as represening he influence of world marke. As foreign capial resricions are lifed in he mos counries will be an increase in he degree of correlaion beween he local marke and oher financial markes around he world, as well as an increase in he link beween he foreign exchange and sock markes. Our focus is on he long-run equilibrium (coinegraing) relaionship beween sock prices and he real exchange rae in a number of Middle Eas oil producer counries, and i conribues o he lieraure in he following ways. Firsly, in line wih Phylakis-Ravazzolo (005), we consider he possibiliy ha he lack of relaionship beween he sock and foreign exchange markes in a counry migh be due o he omission of an imporan variable from he sysem, which acs as a condui hrough which he real exchange rae affecs he sock marke, and possibly invalidaes he resuls of some of he previous sudies. However, conrary wih Phylakis-Ravazzolo (005), we find ha he variable esablishing a causal link (in he long-run) beween sock price and real exchange rae is no he US sock price, bu he oil price. Secondly, given he non normaliy and heeroscedasiciy in he residuals of he full sysem of equaions described hrough a Vecor Error Correcion Model, VECM, we use no only he reduced rank regression echnique, advocaed by Johansen (988), bu also a Quasi Maximum Likelihood esimaion mehod. Finally, we use he persisence profile echnique (Pesaran and Shin, 996) o examine he speed hrough which he sock marke reurns o is long-run equilibrium sae, once i is shocked away. The organizaion of he paper is as follows: secion inroduces he lieraure review, secion 3 describes he daa and 5

6 he mehodology, secion 4 discusses he empirical resuls, and secion 5 provides he summary and conclusions.. Lieraure review For he pas few decades, he relaionship beween exchange raes and sock markes has been given much aenion in he academic lieraure. Sudies have aemped o deermine how one financial marke can predic he ohers and vice versa. Early sudies (Aggarwal, 98); Solnik. 987; Soenen and Hennigar, 988) considered only he correlaion beween he wo variables. Aggarwal (98) finds ha sock reurns and U.S. exchange raes are posiively correlaed. Solnik (987) observes a weak bu posiive relaionship beween he wo variables. Soenen and Aggarwal (989) re-assess he Solnik model using daa for he same eigh indusrial counries. They repor a posiive correlaion beween sock reurn and exchange raes for hree counries and negaive correlaion for five. Soenen and Hennigar (988) conclude ha he value of he U.S. dollar is negaively correlaed, ha is, depreciaion of he U.S. dollar increases he U.S. sock price indexes. Roll (99) finds a posiively relaionship beween marke indices and exchange rae. Smih (99) uses a Porfolio Balance Model o examine he deerminans of exchange raes. The resuls show ha equiy values have a significan influence on exchange raes bu he sock of money and bond has lile impac on exchange raes. Bahmani-Oskooee and Sohrabian (99) are among he firs o use coinegraion and Granger causaliy o explain he direcion of movemen beween exchange raes and sock prices. Since hen various oher papers have appeared covering boh indusrial and developing counries (for example, Ajayi e al. 998, Granger e al, 000; Ibrahim, 000). The direcion of causaliy in he shor run, similar o earlier correlaion sudies, appears mixed. Adrangi and Ghazanfari (996) es for causaliy relaionship beween he dollar exchange rae and he sock reurn in Germany and US. They found ha sock reurns cause he changes in he exchange rae of he dollar. Ajayi, Friedman, and Mehdian (998) invesigae causal relaions beween sock reurns and changes in exchange raes in 6 advanced and emerging counries, hey found unidirecional causaliy beween he sock and currency marke in all he advanced economies while no consisen causal relaions are observed in he emerging economies. Huang, Granger and Yang (000) use daily daa for Hong Kong, Indonesia, Japan, Souh Korea, Malaysia, Philippines, Singapore, Thailand and Taiwan. The resuls showed ha mos markes exhibi bidirecional causaliy beween he wo variables. Nagayasu (00) analyses empirically he recen Asian financial crisis using he ime series daa of exchange raes and sock indices for Philippines and Thailand which were he firs wo counries confroned by massive movemens in financial asse prices. He found unidirecional causaliy runs from he financial secor index o he exchange rae, conagion effecs running from Thailand o he Philippines. Haemi and Irandous (00) also find ha Granger causaliy is unidirecional running 6

7 from sock prices o exchange raes in Sweden. Haemi, and Roca (005) examine he link beween exchange raes and sock prices before and during he 997 Asian crisis, for Indonesia, Malaysia, Philippines, and Thailand. They find ha wih he excepion of he Philippines, during he period before he Asian crisis, here was a significan causal relaionship beween exchange raes and sock prices in each of he four Asian counries. Causaliy ran from he former o he laer in he case of Indonesia and Thailand, while he direcion of causaliy is reversed in he case of Malaysia. During he Asian crisis period, however, he relaionship beween hose wo variables ceased across he all counries. Mos researchers are ineresed in esing for no only he shor-run bu also he long-run relaionship beween exchange raes and sock prices. Oskooee and Sohrabian (99) es for he relaionship beween he S&P price index and he effecive exchange rae of he dollar, finding bidirecional causaliy relaionship beween he wo markes a leas in he shor-run, he coinegraion analysis reveals ha no long-run relaionship beween he wo variables. Raner (993) ess wheher he US dollar exchange rae affecs US sock prices; he concludes ha in he long-run hey are no relaed. Ajayi and Mougoue (996) find a negaive shor-run and long-run feedback relaion beween he wo financial markes. Abdala and Murinde (997) examine exchange rae and sock prices ineracions in some emerging financial markes namely, India, Korea, Pakisan and Philippines. The resuls showed ha he long-run relaionship found only in India and he Philippines. In he shor-run, hey found unidirecional causaliy from he exchange raes o sock prices in all he sample counries excep he Philippines. Wu (000) explores he exisence of an equilibrium relaionship beween sock prices and exchange raes in Singapore asse marke and is sensiive o differen currencies. He concludes ha Granger causaliy runs only one way from exchange raes o sock prices, he coinegraion analysis sugges ha Indonesia Rupiah has a posiive long run effec on sock prices. Morley and Penecos (000) invesigae he naure of he relaionship beween sock prices and spo exchange raes for Canada, France, Germany, Ialy, Japan, UK and USA. They find ha he lack of correlaion beween he level of sock prices index and he level of he exchange raes is due o he fac ha exchange raes and sock prices do no exhibi common rends, bu raher exhibi common cycles. Thus he saisical relaionship is a shor-run raher han long-run or rend relaionship. Lee and Nieh (00) examine boh shor-run comovemens and long-run equilibrium relaionships beween sock prices and exchange raes for each G-7 counry: Canada, France, Germany, Ialy, Japan, he Unied Kingdom (U.K.) and he US. Their findings sugges ha no long run equilibrium relaionship exiss beween he wo variables. However, in he shor-run he causaliy runs from exchange raes o sock prices in Germany, Canada and he UK, and runs from he laer o he former in Ialy and Japan. Doong, Yang, and Wang (005) examine he dynamic relaionship and pricing of sock and exchange rae, using Weekly daa for Indonesia, Korea, Malaysia, Philippines, Thailand and Taiwan. They find ha 7

8 sock prices and exchange raes are no coinegraed, using Granger causaliy es, bidirecional causaliy can be deeced in all counries excep Thailand. Several researchers consider he quesion of wha oher macroeconomic facors hey migh include in he exposure regression. Differen macroeconomics facors including ineres raes, money reserve, inflaion, differen moneary policies, ec., have been applied o he exchange rae exposure model by various researchers. Ibrahim (000) exends he exising sudies on he sock prices- exchange raes causal relaionship by invesigaing he issue for Malaysia. He used hree exchange raes, namely, nominal effecive exchange rae, real effecive exchange rae and bilaeral exchange rae. Using Monhly daa from January 979 o June 996, applying coinegraion and Granger causaliy ess he found ha, in he bivariae models, no long run relaionship beween he sock marke index and any of he exchange raes. In he mulivariae ess (exchange raes, sock prices, money supply and reserves) here is a unidirecional causaliy from he sock marke o he exchange raes, a feedback effec from he bilaeral rae o he sock marke, boh he exchange raes and he sock index are Granger causaliy by he money supply and reserves. Paro, Wald and Wu (00) examine he deerminans of foreign exchange rae risk exposures for equiy index reurns of 6 OECD counries for he period Using weekly observaions and GARCH specificaion, hey find significan ime-varying foreign exchange risk exposure. An imporan issue is wha deermines his exposure. Using panel daa which allow hem o pool daa across counries and hus improve esimaion efficiency, hey found ha several macroeconomic variables can help explain foreign exchange exposure. These variables include expors, credi raing, and ax revenue. Phylakis, and Ravazzolo (005) examine he long run relaionship beween sock prices and exchange raes and he channels hrough which exogenous shocks impac on hese markes, using monhly daa from January 980 o December 998 for Hong Kong, Indonesia, Malaysia, Philippines, Singapore, Thailand, conducing Coinegraion and mulivariae Granger causaliy ess, hey found ha sock prices and exchange raes are posiively relaed,, he financial crisis had emporary effec on he long run comovemens of hese markes, and he US sock marke is an imporan (causing) variable, which acs as a condui hrough which he foreign exchange raes and he local sock markes are linked. The above sudies clearly indicae a srong ineres on he relaionship beween he exchange rae and sock prices wih he use of differen mehodologies and daa ses. There is no consensus among researchers on he empirical validiy of he relaionship beween sock prices and exchange raes; however, suggesing ha furher research is needed o shed ligh on his issue. This ineres on wheher sock prices and exchange raes are relaed has become more pronounced especially afer he Eas Asian crisis. During he crises he counries affeced saw urmoil in boh currency and sock markes. If sock prices and exchange raes are relaed and he causaion runs from exchange 8

9 raes o sock prices hen crises in he sock markes can be prevened by conrolling he exchange raes. Moreover, counries can exploi such a link o arac/simulae foreign porfolio invesmen in heir own counries. Alernaively, if he causaion runs from sock prices o exchange raes hen auhoriies can focus on domesic economic policies o sabilize he sock marke. If he wo markes/prices are relaed hen invesors can use his informaion o predic he behaviour of one marke using he informaion on oher marke. 3. Daa and Mehodology We focus on four Middle Eas counries, namely Egyp, Kuwai, Oman and Saudi Arabia. The sample period a monhly frequency varies for each counry depending on he availabiliy of daa. For Egyp he sample period is 994:-006:06; for Kuwai 99:09-006:0; for Oman 996:05-006:05; and for Saudi Arabia 994:0-006:04. The daa consis of monhly local sock marke index of each counry, local bilaeral spo exchange raes as domesic currency per US dollar, consumer price index CPI, OPEC baske oil prices and S&P 500 index. All observaions were obained from DaaSream and Inernaional Financial saisics (IFS); he observaions are end of he monh. All he series are expressed in logarihmic form. The real exchange rae is defined as: InRER MEC = InCPI Ine InCPI, () MEC MEC US where MEC CPI, is he consumer price index for he Middle Eas Counry, MEC e is he nominal exchange rae and US CPI is he consumer price index for US. 3. Uni roo ess We employ wo procedures, namely he augmen Dickey- Fuller (979) (ADF) es and Kwiakowski, Phillips, Schmid, and Shin (99) (KPSS), o deermine wheher he univariae ime series conain a uni roo. The ADF es is based on he regression, y p + γ j y j ε, () j= = α + βy + where y is he series being esed and p is he number of lags differenced included o capure any auocorrelaion, he null hypohesis is ha β = 0 for he uni roo process. If β < 0, we accep he alernaive hypohesis ha he series is a saionary series. 9

10 In he Dickey- Fuller ype uni roo ess he presence of uni roo is he null hypohesis o be esed. This es is criicized on he ground ha heir failure o rejec a uni roo may be aribued o heir low power. Therefore, we use also he (KPSS) es (Kwiakowski e al., 99); which ess null hypohesis of his es is saionary for each series in levels. This es is implemened as a complemenary procedure o he ADF es. The KPSS saisic is based on he residuals from he OLS regression of y on he exogenous variables x : The KPSS es saisic is being defined as: LM y = x δ + u (3) ( T ) 0 = S / f, (4) where f 0 is an esimaor of he residual specrum a frequency zero, T is he number of observaions and S is a cumulaive residual funcion: T S = uˆ (5) = by, The relaionship beween real exchange raes and domesic sock prices can be represened SP MEC MEC = β 0 + βrer + ν, (6) where MEC SP is he domesic sock price, MEC RER is he real exchange rae defined as domesic price level relaive o foreign prices muliplied by nominal exchange rae and ν is a disurbance erm. All daa are ransformed by naural logarihms. We will use he real exchange rae insead of he nominal for wo reasons. Firsly, following Chow e al (997) he real exchange rae reflecs beer he compeiive posiion of an economy wih he res of he world, and secondly he nominal exchange rae of our sample counries has no varied subsanially during he period of sudy. Alhough we cas he discussion in nominal erms, i should be noed ha due o he shor-run rigidiy of prices, he effec would be similar in real erms. 3. Coinegraion In order o es for coinegraion we use he Johansen (988) and Johansen and Juselius (990) full informaion maximum likelihood of a Vecor Error Correcion Model, Y Y Y Y = Π p + Γ + Γ Γp p+ + (7) Y ε where ε are whie noise Gaussian residuals, Γ s are he lagged of firs differences coefficiens which capure he shor-run effec, Π is he long-run muliplier marix of coefficiens, and in he 0

11 case of coinegraion, is such ha Π = αβ ', where α represens he speed of adjusmen o disequilibrium, while β is a marix of coinegraing vecors. Tesing for coinegraion, using he Johansen s reduced rank regression approach, cenres on esimaing he marix Π in an unresriced form, and hen esing wheher he resricion implied by he reduced rank of Π can be rejeced. In paricular, he number of he independen coinegraing vecors depends on he rank of Π, which in urn is deermined by he number of is characerisic roos ha differen from zero. The es for nonzero characerisic roos is conduced using he λ race and λ max saisics: λ race ( r) = T k i= r+ ) ln( λ ) i (8) λ ) ( r, r + ) = T ( λr ) max +, (9) where λ ) s are he eigenvalues of Π, T is he number of usable observaions. While he saisic ess he null hypohesis ha he number of disinc coinegraing vecors is less han or equal o r agains a general alernaive, and he λ race λmax saisic ess he null ha he number of disinc coinegraing vecors is r agains he alernaive hypohesis of r + coinegraing vecors. Cheung and Lai (993) show ha, he race es is more robus o boh skewness and excess kurosis in he residuals han he maximum eigenvalues es, herefore we rely on he λ race o es for coinegraing rank, we also correced for small sample bias (see Reimers, 99, and Phylakis and Ravazzolo, 005). Thus we use (T- nk) in Eq. (8) insead of T. Also Rahbek e al. (00) have shown ha he coinegraion rank race es is robus agains moderae residual ARCH effecs (Juselius, 006). The lag lengh of he VECM has been seleced using SBC crieria, k' log Σ ) + log( T ), (0) T where Σ ) is he variance-covariance marix of residuals, T is he number of observaions, and k ' is he oal number of regressors in all equaions. 3.3 Vecor error correcion model: We explore he presence of regime shifs in he coinegraing relaionship in wo ways. Firsly we spill he sample in wo sub periods and apply Johansen coinegraion mehod. Secondly

12 we use he whole sample and include slope dummies in he VECM which describes he coinegraion relaionship among sock prices, real exchange raes and oil prices as follows: SP = ω SP + α D ( SP + η RER δ γ RER + η OIL γ OIL + α ( SP ) + ε δ γ RER γ OIL ) () RER + α D ( SP = η SP 3 + ω RER δ γ RER + η OIL γ OIL 4 ) + ν + α ( SP δ γ RER γ OIL ) () OIL = η SP + α D ( SP η RER 6 δ γ RER + ω OIL γ OIL 3 ) + ψ + α ( SP 3 δ γ RER γ OIL ) (3) where is he firs order difference operaor, rae, SP is domesic sock prices, RER is real exchange OIL is oil prices and D is dummy variable akes value 0 before Mar. 999 and value from Mar. 999 onwards. This dummy specificaion allows capuring he regime shif due o he oil prices shock in March 999 afer OPEC meeing. Furhermore, he coefficiens α s andα s in each equaion capure he speed of adjusmen owards o he long-run relaionship in he pre oil shock and pos oil shock regime, γ and γ capure he coinegraing vecor coefficiens; and ε, ν and ψ are saionary residuals. i i Given non-normaliy and heeroscedasiciy in he residuals of he VECM and given also he presence of slope dummies, we canno use he reduced rank regression echnique (equivalen o Full Informaion Maximum Likelihood) suggesed by Johansen (990). Therefore, all he parameers of he full sysem given by he equaions described by (), () and (3) are esimaed by maximising he log-likelihood funcion assuming normaliy in he residuals: T Tg T log(π ) + T log de Γ log Σ ( YΓ X B) Σ ( YΓ X B)' (4) where T he number of observaions, g he endogenous variables, Y denoes endogenous variables, X denoes an = xg marix of xk marix of exogenous or predeermined variables, Γ denoes a gxg marix of coefficiens, B denoes kxg marix of coefficiens, k is he number of exogenous or predeermined variables, Σ denoes gxg marix of covariance.

13 In a second sage, we use a robus esimaor of he covariance marix of he parameers, using he following equaion: L w ( Y ' uu ky k ) (5) k = L where L is he number of lags of auocorrelaion in he form of moving average erm, Y a lis of variables, uis a single series of residuals, and w is a se of window weighs which defined as: L + k w = k = L, L +,...,0,..., L, L (6) L Persisence profiles: In order o measure, wihin a sysem of equaions, he speed hrough which he sysem revers o is long-run equilibrium once i is shocked away, we use he persisence profile which has been proposed by Pesaran and Shin (996). Specifically, he persisence profile a horizon s, P(s), measures he (dynamic) response of a coinegraing relaionship o sysem wide shocks (occurred in -s) and i is given by: ( s) = β ' H s ΣH ' β / β ' Σβ P for s = 0,,... (7) s where Σ is he variance-covariance marix of he VAR innovaions, and s * ( ) Cs H = C + is he nxn coefficiens marix of he Moving Average, MA represenaion of he VECM. In he long-run H s ends o he long-run muliplier marix C (), while a ime zero (e.g., on impac) we have H = Ι m The 0. * Cs marix conains he ransiory componens of he sysem, whose values converge oward zero while s goes o infiniy. This implies ha he raio given in (7) converges owards zero as s grows, since in presence of coinegraion he following orhogonal condiion holds: β ' C() = 0. The smaller is he horizon s for which P(s) converges o zero, he faser is he re-adjusmen owards he long-run equilibrium. The persisence profiles are derived from he FIML esimaion of he vecor error correcion models used in he previous secion for he coinegraion analysis. 4. Empirical resuls 4. Uni roo ess 3

14 Using ADF and KPSS he resuls in able clearly show ha all he variables are no saionary in he levels; we also find ha all he series are saionary in he firs differences a 5% level of significance. 4. Bivariae Coinegraion resuls Having esablished he order of inegraion of he individual series, we are furher ineresed in deermining wheher here exiss a long-run equilibrium relaionship beween sock prices and real exchange raes, he Johansen coinegraion es is used for his purpose. As one can observe from Table using he whole sample he empirical findings from he Johansen mehod for he long-run relaionship a 5% significance level, we find evidence of no coinegraion beween sock prices and real exchange raes in Egyp, Kuwai, Oman and Saudi Arabia. These preliminary findings seems o be in line wih he following sudies, Oskooee and Sohrabian (99) using Engle and Granger mehod hey found no coinegraion beween he wo variables. Raner (993) also did no find a coinegraion relaionship beween he wo variables and argued his o he raional expecaion heory which does no suppor a srong relaionship beween exchange raes and sock prices. Abdala and Murinde (997) find no long-run relaionship beween he wo variables in India and Philippines. Morley and Penecos (000) using he EG mehod conclude ha no coinegraion relaionship beween he wo variables, he reason of ha is due o he fac ha exchange raes and sock prices do no exhibi common rends, bu raher exhibi common cycle. Ibrahim (000) using EG and Johansen mehods finds no coinegraion beween exchange raes and sock prices, he suggess ha he lack of coinegraion may be due o he omission of imporan and heoreically sound variables from he models. Lee and Nieh (00) find no coinegraion beween he wo variables in he G-7 counries, hey conclude ha hese wo financial asses share no common rend in heir economy sysem and hence hey will move apar in he long-run. Nandha and Smyh (003) conclude ha here is no coinegraion beween foreign exchange and domesic sock prices because he changes in he exchange raes influence firms expors and ulimaely affec sock prices. Phylakis, and Ravazzolo (00) also find no coinegraion beween he wo variables, he reason was he omission of an imporan variable, namely he US sock marke. However, in line wih Ibrahim (000) and Phylakis, and Ravazzolo (005), we consider he possibiliy ha he lack of coinegraion migh be due o he omission of imporan variables. Therefore, in Table 3 we repor he resuls for a sysem which includes, as addiional endogenous variables, eiher he oil prices or he US sock prices, in order o examine wheher hese variables affec sock prices and real exchange raes in long-run relaionship. The λ race es saisics shows ha we can no rejec he null hypohesis of no coinegraing vecor among SP, RER and P US in 4

15 Egyp, Oman and Saudi Arabia, while here is a long-run relaionship beween he aforemenioned variables in Kuwai a 5% level of significance. When esing for a zero exclusion resricion (using he reduced rank regression algorihm developed by Johansen and Juselius, 990) for each coefficien of he coinegraing vecor describing he long run relaionship among SP, RER and P US in Kuwai, we find (see Table 4) ha we can exclude domesic sock price index from he coinegraion space. This implies ha, for he whole sample, he sock price index in Kuwai does no have a long-run equilibrium relaionship wih oher variables in he sysem. I is imporan o observe ha he reduced rank regression algorihm developed by Johansen and Juselius (990) relies upon Gaussian and iid residual in he VECM. Consequenly, for he reasons given above, he inference resuls should be aken wih cauion. We also argue ha he absence of long-run equilibrium relaionship migh be due o he exisence of a regime shif, corresponding o he oil shock in March 999 consequen o an OPEC meeing. Using he λ race, Table 5 shows ha, a 5% significance level, we can no rejec he null hypohesis of no coinegraion beween SP and RER or among SP, RER and P US for each subsample. However, he Johansen λ race suggess, a 5% significance level, he exisence of coinegraion among SP, RER and OIL, in Egyp, Kuwai, Oman and Saudi Arabia in he second sub sample. We also es for zero exclusion resricions for each variable included in he coinegraing vecor among he riple SP, RER and OIL. For his purpose we, again, use he reduced rank regression algorihm developed by Johansen and Juselius (990). From Table 6 we can observe ha he null hypohesis of exclusion was rejeced in all counries (wih excepion of Kuwai). These findings confirm he previous resuls obained hrough he λ race es suggesing he exisence of a unique coinegraion relaionship among sock prices, real exchange raes and oil prices. Finally, when concenraing on a simple bivariae sysem wih only sock and oil prices for Kuwai, we can rejec he null hypohesis of no coinegraion (given a suggess ha here is a long-run relaionship beween sock and oil prices. λ race equal o 8.8), and his finding 4.3 Coinegraion analysis based upon Quasi Maximum Likelihood We use Maximum Likelihood o esimae joinly all he coefficiens in he VECM described by equaions 0, and ; he parameer sandard errors have been obained using a robus covariance marix esimaor. From Table 7 we can observe ha he speed of adjusmen coefficiens, regarding he firs regime, ha is heα s are no saisically significan. This finding i We used he RATS program for esimaing he VECM using full informaion maximum likelihood mehod which esimaes he likelihood funcion under he assumpion ha he conemporaneous errors have a join normal disribuion. Using he robus errors opion we correced he covariance marix esimae o allow for more complex behaviour of he residuals, his opion correcs he heeroscedasiciy and serial correlaion, his is some imes known as he HAC (Heeroscedasiciy and Auocorrelaion Consisen) covariance marix. 5

16 confirms ha no long-run co-movemen exiss among RER, SP and OIL in he firs regime (pre 999 oil shock). The speed of adjusmen coefficiens regarding he second regime, e.g. heα i saisically significan and wih he correc sign in Egyp, Oman and Saudi Arabia. More specifically, he resuls in Table 7 show ha he oil prices play an imporan role in bringing back he sock prices o heir long-run equilibrium level. Furhermore, we also find ha in Egyp he real exchange rae plays a role in re-esablishing he long-run equilibrium for he sock prices. Furhermore, he QML resuls confirm our findings for Kuwai obained hrough he reduced rank regression echnique. is In he case of Kuwai, here is no long-run relaionship among sock prices, real exchange raes and oil prices, so ha we esimaed he VECM for he sock prices and oil prices. A he % level of significan we can rejec he null hypohesis of no coinegraion beween he wo variables (he speed of adjusmen is significan a % level of significance in he oil prices equaion), and oil prices coefficien in he coinegraing vecor (.67) is significan a % and posiively relaed wih sock prices. Table 8 presens he long-run coinegraing vecors, in every case he oil prices are posiively relaed o he domesic sock marke, we can explain his posiive relaionship as follows; he rise in world oil prices improves he rade balance, leading o a higher curren accoun surplus and improving ne foreign asse posiion. A he same ime, higher oil prices end o increase privae disposable income and corporae profiabiliy, increasing domesic demand and sock prices. In Egyp and Oman he real exchange raes are posiively relaed o sock price indices, while in Saudi Arabia i is negaively relaed. One explanaions of he posiive comovemen beween real exchange raes and sock marke indexes in Egyp and Oman may be explained as follows: an increase in he oil prices conveys informaion abou an improved performance of Egyp and Oman economy and implies an increase in heir expors. Tha leads on he one hand, o an appreciaion in heir currencies and a rise in heir real exchange rae, and on he oher hand, o an increase in heir domesic economic aciviy, which causes he local sock marke o rise. Thus, a rise in real exchange rae may increase sock prices hrough is effec on economic aciviy. In conras, a negaive relaionship beween sock prices and real exchange raes in Saudi Arabia can be explained as follows: The fall in he real exchange rae in Saudi Arabia make he Saudi socks more aracive for he domesic invesors 3 so hey sell heir foreign currency o buy he domesic socks which leads o boos domesic sock price index. The real exchange rae coninue falling because he nominal exchange rae is fixed agains he dollar in ha case he real 6

17 exchange rae can only change due o variaions in he price levels, looking a he CPI variaions beween he Saudi CPI and US CPI (see figure ) we can noe ha i is going downward in he enire sample period, for ha reason he real exchange rae keep going downward whereas he domesic sock index going upward. 4.4 Persisence Profiles Afer esimaing he parameers of he VECM using he Quasi Maximum Likelihood approach described in secion 4.3, we examine he persisence profiles following Pesaran and Shin (996) 4. As explained before, hese profiles measure he speed hrough which a sysem of variables revers back o he long-run equilibrium once i is shocked away. From Figures, 3, 4 and 5, he convergence o he long run equilibrium appears go faser in Egyp and Saudi Arabia han Oman and Kuwai. Specifically, on he one hand he sysem of variables given by SP, RER and OIL akes 7, 4 and monhs o rever back o he long run equilibrium value in Egyp and Saudi Arabia, and in Oman; on he oher hand, i akes 4 monhs for he Kuwai sock price o rever o is long run relaionship wih he oil price. 5. Summary and conclusion This paper analyses he long-run ineracion among sock prices and he real exchange rae in four oil exporing Middle Eas counries using coinegraion analysis. We sar from applying he reduced rank regression echnique (equivalen o FIML) o esimae a VECM for he whole sample period. This exercise does no produce any evidence of coinegraion beween sock prices and real exchange rae in he counries under invesigaion. In line wih Phylakis and Ravazzolo (005) we argue ha his resul may be due o he omission of an imporan variable, which acs as a condui hrough which he wo markes are linked. Therefore we incorporae addiional variables o he sysem such as oil prices and a global marke index (using he US sock prices as a proxy). Again he analysis ha focuses on he full sample does no poin o any evidence of coinegraion. We herefore, shif aenion o he possible exisence of a regime shif and divide he sample ino wo subperiods according o he major oil price shock in March 999 consequen o an OPEC meeing. Boh he reduced rank regression echnique and he Quasi Maximum Likelihood approach (robus o non normaliy and heeroscedasiciy in he residuals of he VECM) sugges he exisence, in he second sub period, of a long-run equilibrium relaionship among he sock prices, he real exchange raes and oil prices for hree counries: Egyp, Oman and Saudi Arabia. As for Kuwai boh economeric echniques (employed o esimae he VECM coefficiens) sugges he exisence of a long-run equilibrium relaionship beween sock and oil prices. We find ha, in each counry, oil prices have a long-run posiive effec on sock prices. We also found ha, in Egyp and Oman he 3 Saudi governmen imposes a number of barriers prevening foreign invesors from enering he Saudi sock marke. 7

18 real exchange raes are posiively relaed o sock price, while in Saudi Arabia i is negaively relaed. The persisence profiles show ha he convergence o he long run equilibrium akes 7 and 4 monhs in Egyp and Saudi Arabia respecively, while i akes and 4 mohs in Oman and Kuwai. Our resuls indicae ha, firsly, he oil price is an imporan variable, which acs as a condui hrough which he real exchange raes and domesic sock prices are linked, so ha he oilexporing counries as policy makers in OPEC should keep an eye on he effecs of changes in oil prices levels on heir own economies and sock markes. Secondly, governmen policy makers may play a role in influencing real exchange raes and sock prices hrough he use of oil prices, as he counries in our sample are among he bigges oil producers in he world. Thirdly, he relaionship beween real exchange raes and sock prices may be useful for porfolio managers ineresed in global asse allocaion or invesors rying o hedge agains foreign exchange risk. Also he no coinegraion among real exchange raes, sock prices and US sock marke give he foreign invesors an opporuniy o benefi from ha in diversifying heir porfolio beween he major sock markes like US sock exchange and he emerging markes in he Middle Eas region. References Abdala, I., Murinde, V., 997. Exchange rae and sock prices ineracions in emerging financial markes: Evidence on India, Korea, Pakisan and Philippines. Applied Financial Economics 7, Adrangi, B., Ghazanfari, F., 996. Bilaeral exchange rae of he dollar and sock reurns. Alanic Economic Journal 4, -5. Aggarwal, R., 98. Exchange raes and sock prices: a sudy of he U.S. capial markes under floaing exchange raes. Akron Business and Economic Review, 7- Ajayi, R., Mougoue, M., 996. On he dynamic relaionship beween sock prices and exchange raes. The Journal of Financial Research 9, Ajayi, R., Friedman, J., Mehdian, S., 998. On he relaionship beween sock reurns and exchange raes: ess of Granger causaliy. Global Finance Journal 9(), 4-5. Aquino, R., 005. Exchange rae risk and Philippine sock reurns: before and afer he Asian financial crisis. Applied Financial Economics 5, Barsky, R., Kilian, L., 004. Oil and he macroeconomy since he 970s. Journal of Economic Perspecive 8(4), Bekaer, G., Harvey, C. R., 995. Time-varying world marke inegraion. Journal of Finance 50, The persisence profiles have been obained by a program wrien on Gauss. 8

19 Caporale, M., Piis, N., 997. Causaliy and forecasing in incomplee sysems. Journal of Forecasing 6, Cheung, Y.W. Lai, K.S., 993. Finie-sample sizes of Johansen's likelihood raio for coinegraion. Oxford Bullein of Economics and Saisics 55, Chow, E.H., Lee, W.Y., Sol, M.S The exchange rae risk exposure of asse reurns. Journal of Business 70, Dickey, D., Fuller, W., 979. Disribuion of he esimaors for auoregressive ime series wih a uni roo. Journal of American Saisical Associaion 74, Doong, S,. Yang S., Wang, A., 005. The dynamic relaionship and pricing of sock and exchange rae: empirical evidence from Asian emerging markes. The Journal of American Academy of Business, Cambridge 7(), 8-3. Dornbusch, R. Fischer, S., 980. Exchange raes and curren accoun, American Economic Review 70, Engle, R.F., Granger, C.W.J., 987. Coinegraion and error-correcion: represenaion, esimaion and esing. Economerica 55, Eun, C., Shim, S., 989. Inernaional ransmission of sock marke movemens. Journal of Financial and Quaniaive Analysis 4, Gavin, M., 989. The sock marke and exchange rae dynamics. Journal of Inernaional Money and Finance 8, Granger, C., Newbold, P., 974. Spurious regression in economerics. Journal of Economerics 6, Hamao, M., Ng, V., 990. Correlaions in price changes and volailiy across inernaional sock markes. Review of Financial Sudies 3, Haemi, A., Roca, E., 005. Exchange raes and sock prices ineracion during good and bad imes; evidence from ASAN4 counries. Applied Financial Economics 5, Haemi, A., Irandous, M., 00. On he causaliy beween exchange raes and sock prices: a noe. Bullein of Economic Research 54(), Huang, B., Granger, C., Yang, C., 000. A bivariae causaliy beween sock prices and exchange raes: evidence from recen Asian flu. The Quarerly Review of Economics and Finance 40, Hwang, J., 999. The relaionship beween sock prices and exchange raes: evidence from Canada. Inernaional Advances in Economic Research 5, 397. Ibrahim, M., 000. Coinegraion and Granger causaliy ess of sock prices and exchange rae ineracion in Malaysia. ASEAN Economic Bullein 7(), Io, T., Yuko H., 004. High-frequency conagion beween he exchange raes and sock prices. Working paper 0448, NBER, Cambridge, MA. 9

20 Johansen, S., Juselius, K., 990. Maximum likelihood esimaion and inference on coinegraion wih applicaions o he demand for money. Oxford Bullein of Economics and Saisics 5, Johansen, S., 988. Saisical analysis of coinegraion vecors. Journal of Economic Dynamics and Conrol, Juselius, K., 006. The coinegraed VAR model: mehodology and applicaions, Oxford Universiy Press Inc., New York. Kao, W., Ma, C., 990. On exchange rae changes and sock price reacions. Journal of Business, Finance and Accouning 7(3), Khalid, M., Kawai, M., 003. Was financial marke conagion he source of economic crisis in Asia?: evidence using mulivariae VAR model. Journal of Asian Economics 4, Kubarych, R., 005. How oil affec markes. The Inernaional Economy, Kwiakowski, D., Phillips, P., Schmid, and Shin, Y., 99. Tesing he null hypohesis of saionariy agains he alernaive of a uni roo. Journal of Economerics 54, Lean, H., Halim, m., Wong, W., 003. Bivariae causaliy beween exchange raes and sock prices on major Asian counries. Working paper. Lee, C., Nieh, C., 00. Dynamic relaionship beween sock prices and exchange raes for G-7 counries. The Quarerly Review of Economics and Finance 4, Lukepohl, H., 98. Non-causaliy due o omied variables. Journal of Economerics 9, Mishra, A., 004. Sock marke and foreign exchange marke in India: are hey relaed?. Souh Asia Economic Journal 5(), Mohsin, M., Amare, T., 000. Sock prices and exchange raes in he leading Asian economies: shor versus long run dynamics. Singapore Economic Review 45(), Morley, B., Penecos, E., 998. Asse pricing and foreign exchange risk: economeric evidence for he G7. Journal of Inernaional Money and Finance 7, Morley, B., Penecos, E., 000. Common rends and cycles in G-7 counries exchange raes and sock prices. Applied Economics Leers 7, 7-0. Nagayasu, J., 00, Currency crisis and conagion: evidence from exchange rae and secor sock indices of he Philippines and Thailand. Journal of Asian Economics, Nandha, m., Smyh, R., 003. Bivariae causaliy beween exchange raes and sock prices in Souh Asia. Applied Economics Leers 0, Oskoonee, M., Sohrabian, A., 99. Sock prices and he effecive exchange rae of he dollar. Applied Economics Leers 4, Paro, D., Wald J., Wu, Y., 00. Explaining exchange rae risk in world sock markes: a panel approach. Journal of Banking and Finance 6, Pesaran M.H., Shin Y., 996. Coinegraion and speed of convergence o equilibrium. Journal of Economerics 7,

21 Phylakis, K., Ravazzolo, F., 005. Sock prices and exchange rae dynamics. Journal of Inernaional Money and Finance 4, Rahbek, a., Hansen, E., Dennis, J., 00. ARCH innovaion and heir impac on coinegraion rank esing. Preprin no. 998, deparmen of heoreical saisics. Working paper no., Cenre for Analyical Finance. Raner, M., 993. A coinegraion es of he impac of foreign exchange raes on U.S. sock marker prices. Global Finance Journal 4, Reimers, E., 99. Comparisons of ess for mulivariae coinegraion. Saisical Papers 33, Roll, R., 99. Indusrial srucure and he comparaive behaviour. The Journal of Finance 47(), 3-4. Smih, C., 99. Sock marke and he exchange rae: a muli-counry approach. Journal of Macroeconomics 4, Smih, C., 99. Equiies and UK exchange rae. Applied Economics 4, Soenen, A., Aggarwal, R Financial prices as deerminans of changes in currency values. Paper presened a he 5h Annual Meeings of Easern Finance Associaion, Philadelphia. Soenon, L., Hennigar, E., 988. An analysis of exchange raes and sock prices in he U.S. experience beween 980 and 986. Akron Business and Economic Review 9, 7-6. Solnik, B., 987. Using financial prices o es exchange rae models: a noe. Journal of Finance 4, Wu, Y., 000. Sock prices and exchange raes in a VER model- he case of Singapore in he 990s. Journal of Economics and Finance 4(3),

22 Appendix Table (): uni roo ess: For sock prices, real exchange raes, US sock prices and oil prices. Panel (): uni roo ess for real exchange raes ADF KPSS levels s difference levels s difference No rend rend No rend rend No rend rend No rend rend Egyp * -9.06*.05* 0.3* Kuwai * -3.3* 0.75* 0.7* Oman * -8.6*.8* 0.5* Saudi Arabia * -0.87*.43* 0.7** Panel (): uni roo ess for sock prices Egyp * -9.05* 0.69* 0.4* Kuwai * -7.60* 0.88* 0.30* Oman * -8.4* * Saudi Arabia * -7.93*.8* 0.30* Panel (3): uni roo ess for Oil prices and US sock prices Oil prices * -.74*.* 0.9* US sock * -.99* 0.73** 0.8* *, **, ** indicae Significance a %, 5% and 0% levels.respecively The %, 5% and 0% ADF criical values for he model wihou ime rend are , and respecively, while he same criical values for he model wih ime rend are -4.07, and respecively. The %, 5% and 0% KPSS criical values for he model wihou ime rend are 0.739, and respecively, while he same criical values for he model wih ime rend are 0.6, 0.46 and 0.9 respecively. The criical values for ADF ess are provided by Mackinnon (996), while criical values for KPSS ess are provided by Kwiakowski, Phillips, Schmid, and Shin (99). The able shows ha all variables are no saionary in he levels bu however, saionary in he firs differences. Table () Johansen coinegraion ess: For sock prices and real exchange raes in he enire period H0 H Saisics Egyp λ r =0 r>0 3.4 race r r>.55 Kuwai λ r =0 r> race r r> 6.0 Oman λ r =0 r> race r r>.58 Saudi Arabia λ r =0 r> race r r>.90 Sample periods: Egyp Dec Jun 006, Kuwai Sep.99-Feb. 006, Oman Jun.996-May 006, Saudi Arabia Jan.994-Apr.006, if r denoes he number of significan vecors, hen he Johansen race saisics es he hypoheses of a mos one and zero coinegraing vecors, respecively. The criical values inroduced by Mackinnon, Haug and Michelis (999) were used. The saisics include a finie sample correcion (see Reimers (99)). The able shows ha here is no long-run relaionship beween sock prices and exchange raes in he all counries.

23 Table (3) Mulivariae coinegraion resuls: For sock prices, real exchange raes, US sock prices and oil prices in he enire period. Egyp Egy Egy SP, RER, P SP Egy, RER Egy US, OIL λ race λ race Ho H Saisics r =0 r r r =0 r r r>0 r> r> r>0 r> r> Kuwai Ku Ku SP, RER, SP Ku, RER Ku P US, OIL λ r =0 race r r λ r =0 race r r r>0 r> r> r>0 r> r> 39.70** Oman Om Om SP RER, P SP US, race RER, OIL Om Om, race λ r =0 r r λ r =0 r r r>0 r> r> r>0 r> r> Saudi Arabia Sa Sa SP RER, P SP US, race RER, OIL Sa Sa, race λ r =0 r r λ r =0 r r r>0 r> r> r>0 r> r> If r denoes he number of significan vecors, hen he Johansen race saisics es he hypoheses of a mos wo, one and zero coinegraing vecors, respecively. The criical values inroduced by Mackinnon, Haug and Michelis (999) were used. The saisics include a finie sample correcion (see Reimers (99)). *, **, ** indicae Significance a %, 5% and 0% levels respecively, he able shows here is no coinegraion relaionship among sock prices, real exchange raes and US sock prices, or among sock prices, real exchange raes and oil prices in he all counries wih excepion of Kuwai during he enire period. Table (4) Ku Ku US Tes of exclusion resricion for SP, RER, P in Kuwai Kuwai MEC P MEC S US P Ku KU US SP, RER, P ** 3.45*** *, **, *** denoe significance a %, 5% and 0% respecively, Figures are χ² () saisics. The able shows ha we can exclude he sock prices from he coinegraion relaionship. 3

24 Table (5): Mulivariae coinegraion resuls of subperiods: For sock prices, real exchange raes, US sock prices and oil prices in he wo subperiods. Panel (): Coinegraion beween sock prices and real exchange raes Egyp Dec.994- Feb.999. Mar.999-Jun.006. Kuwai Sep. 99- Feb. 999 Mar.999- Feb. 006 Oman Jun Feb. 999 Mar May. 006 Saudi Arabia Jan Feb. 999 Mar Apr. 006 Ho: r = r Panel (): Mulivariae coinegraion among sock prices, real exchange raes and US sock prices Ho: r = 0 r r Egyp Dec.994- Feb.999. Mar.999-Jun.006. Kuwai Sep. 99- Feb. 999 Mar.999- Feb. 006 Oman Jun Feb. 999 Mar May. 006 Saudi Arabia Jan Feb. 999 Mar Apr Panel (3): Mulivariae coinegraion among sock prices, real exchange raes and oil prices Egyp Dec.994- Feb.999. Mar.999-Jun.006. Kuwai Sep. 99- Feb. 999 Mar.999- Feb. 006 Oman Jun Feb. 999 Mar May. 006 Saudi Arabia Jan Feb. 999 Mar Apr * * * ** *, **, *** denoe significance a %, 5% and 0% respecively, Figures are λ race saisics, here is no coinegraion beween sock prices and real exchange raes, also here is no coinegraion beween sock prices, real exchange raes and US sock prices in he all counries in he wo sub periods, however, he able shows a coinegraion relaionship beween sock prices, real exchange raes and oil prices in he all counries during he second sub period. 4

25 Table (6) Tes of exclusion resricion for sock prices, real exchange raes and oil prices. SP RER OPIC OIL Egyp 4.93* 3.68*** 7.86* Kuwai 8.65*.4.86* Oman 8.9* 5.76**.94* Saudi Arabia 8.47* 3.7*** 5.4* *, **, *** denoe significance a %, 5% and 0% respecively, Figures are χ² () saisics. The coinegraion relaionship verified beween sock prices, real exchange raes and oil prices in he all counries wih excepion of Kuwai. Table (7) Vecor Error Correcion resuls: For sock prices, real exchange raes and oil prices in he enire period. SP = ω SP + η RER + η OIL + α ( SP δ γ RER γ OIL + α D ( SP RER + α D ( SP = η SP OIL = η SP 3 + α D ( SP 3 5 δ γ RER δ γ RER + ω RER δ γ RER γ OIL ) + ε α α SP Egyp Kuwai Oman Saudi Arabia η OIL 4 γ OIL ) + ν RER α α + α ( SP Egyp *** Kuwai Oman Saudi Arabia η RER 6 + ω OIL 3 γ OIL ) + ψ + α ( SP OIL α 3 α 3 Egyp * Kuwai Oman * Saudi Arabia *, **, ** indicae Significance a %, 5% and 0% levels.respecively * Where SP is domesic sock prices, RER is real exchange rae, OIL is oil prices and 3 δ γ RER δ γ RER γ OIL γ OIL ) D is dummy variable akes value 0 before Mar. 999, and value from Mar. 999, o capure he regime shif (second regime) based on he oil prices shock in March 999 afer OPEC meeing,, α i capure he long-run relaionship in he firs regime, while α i capure he long-run relaionship in he second regime, γ and γ capure he coinegraing vecor, ε, ν and ψ are saionary random processes inended o capure oher perinen informaion no conained in lagged values of SP, RER and OIL.We esimae he sysem for each counry using he full informaion maximum likelihood (FIML) approach o gain efficiency, we correced he covariance marix esimae o allow for more complex behaviour of he residuals, his opion correcs he heeroscedasiciy and serial correlaion. The able shows ha, here is long-run relaionship beween sock prices, real exchange raes and oil prices in he second regime capured byα 3 in he all counries wih excepion of Kuwai. In he firs regime here is no coinegraion among sock prices, real exchange raes and oil prices, while here is a coinegraion relaionship among he hree variables in he second regime in he all counries wih excepion of Kuwai. ) ) 5

26 Table (8) The long-run coinegraion vecor for SP = + + δ γ RER γ OIL δ γ γ Egyp *.339* Oman **.454* Saudi Arabia *** **.590* *, **, *** denoe significance a %, 5% and 0% respecively, where SP is he sock prices, δ is he consan, RER is he real exchange rae andoil is he oil prices. The real exchange raes and oil prices are significan in he coinegraing vecor equaion of he second regime. Figure () CPI variaions beween Saudi Arabia and USA CPI variaions beween Saudi Arabia and USA Figure () Persisence profiles for Egyp afer he oil shock a March The sysem resored o he equilibrium afer 7 monhs 6

27 Figure (3) Persisence profiles for Oman afer he oil shock a March The sysem resored o he equilibrium afer monhs Figure (4) Persisence profiles for Saudi Arabia afer he oil shock a March The sysem resored o he equilibrium afer 4 monhs Figure (5) Persisence profiles for Kuwai afer he oil shock a March The sysem resored o he equilibrium afer 4 monhs 7