CHAPTER ONE

INTRODUCTION

1.1 Background to the Study

Oil price fluctuation affects the economy through a number of channels (Eryiğit 2012).
The financial market and capital channel in particular, has gained the attention of authors (
Le and Chang 2011). While the debate around this issue is often to examine the
relationship of crude oil price fluctuation on financial markets, the direct effect on stock
market performance and how adjustments in exchange rate policy (Basher et al,
2010;Imarhiagbe, 2010; Kumar, 2014), as recently observed in 2014 in Nigeria, calls for
further investigation.

The Nigerian economy has been dominated by the crude oil revenue since the early 1970s. The
oil boom of the early 1970s had a persuasive effect on the growth and development of the
economy. Oil suddenly accounted for more than 90 percent of export, contributed about 80
percent to total revenue and this substantially affected the scope and content of investment,
production and consumption patterns as well as government’s policies and programmes.

Thus, Nigeria became increasingly dependent on oil revenue, which in the last few decades
has experienced shocks in its price per barrel and production. With oil revenue as the main
stay of the Nigerian economy, shocks in oil prices are definitely of prime interest to
economists in order to predict the effects of a drastic change-increase or decrease in oil
price, on the Nigerian economy as a whole.

Oil is a natural (hydrocarbon) resource used for different purposes. It is an exhaustible non –
renewable resource. Towards the close of the 20th, oil constituted about 50% of the total energy
demand in the world, with the exemption of centrally planned economies, (Anyawu, Oyefusi,
Oaikhenan, and Dimowo, 1997). Historically, major global oil price fluctuations dated back to
the 1970s when Organization of Petroleum Exporting Countries (OPEC) reacted to the Yom
Kippur War (a war fought by a coalition of Arab States in 1973) by placing an embargo on
oil, against countries like United States, Canada, and Netherlands for supporting Israel in the
war. In 1973, there was a rise in oil revenue accrued to the Nigerian government due to sharp
increase in global oil price caused by the Yom Kippur War. This created extraordinary,
surprising and unforeseen wealth for Nigeria and the exchange rate appreciated as foreign
exchange influxes offset outflows and Nigeria foreign reserves assets increased (Adedipe,
2004). The economy of Nigeria gradually became dependent on crude oil as productivity
declined in other sectors (Englama, Duke, Ogunleye, and Isma, 2010)

In most countries of the world, including Nigeria, the goals of an exchange rate policy include
determining an appropriate exchange rate and ensuring its stability. In 1986 when Federal
government of Nigeria, adopted Structural Adjustment Programme (SAP), sponsored by
the World Bank and International Monetary Fund (IMF). The country’s exchange rates
system moved from a peg regime to a flexible exchange rate regime where exchange rate
is left completely to be determined by market forces of demand and supply but subject
to periodic review by the monetary authority to attain some policy objectives. The stock market
plays a major role in financial intermediation in both developed and developing countries by
channeling idle funds from surplus to deficit unit in the economy.

Furthermore, as the economy of a nation develops, more resources are needed to meet the rapid
expansion. The stock market serves as a channel through which savings are mobilized and
efficiently allocated to achieve economic growth (Alile, 2008). Large and long term capital
resources are pooled through the issuing of shares and stocks by industries in dire need for
finance for expansion purposes. Thus, the overall development of the economy is a function of
how well the stock market performs. Empirical evidences from developed economies as well as
the emerging market have proved that the development of the stock market is sacrosanct to
economic growth (Asaolu and Ogunmuyiwa, 2010).

The stock exchange market has displayed a relatively high degree of volatility in response to the
flexible exchange rate regime that followed the SAP era in 1986. The Nigerian Naira, which is
the most dominating currency in the Nigerian Stock Exchange (NSE) market, has
depreciated several times more than it has appreciated in value relative to other currencies, the
US dollar in particular. It is also important to identify at this point the factors that influence the
behavior of stock prices. Movements in the daily stock prices are influenced by Gross Domestic
Product (GDP), employment, interest rates, corporate performance, exchange rates, trade
balance, inflation, money supply, productivity rates and others. The stock market is used as a
barometer (see Peterside, 2012) to measure the effect of the falling crude oil price on the
economy and the direction exchange rate policy should take..

Historically, in 1960 the Nigerian Stock Exchange (NSE) was formed and known as the Lagos
Stock Exchange. In December 1977 it was renamed as the Nigerian Stock Exchange. Currently
NSE consists of six branches and the Head office is situated at Lagos.

Therefore, it will be interesting to explore the effect and dynamic relationship of these oil prices,
exchange rate and stock prices. Hence this study examines the impact of oil prices and exchange
rates on the stock market dynamics in Nigeria

1.2 Problem Statement

Overtime, one of the most important issue confronting Nigeria today is the prices of oil and its
attendant’s relationship on economic wellbeing of its citizen. Also, aside from the relationship
of fluctuating oil prices and its consequences, the relationship that exchange rate has on the
Nigerian economy is also of great consideration, most importantly the unexpected volatility in
exchange rate of Nigeria.

The economy of Nigeria has been in a declining state since the sharp drop accompanied with
shocks in the prices of crude oil, the country’s major foreign exchange earner. Since June 2014,
the prices of oil that fell from about US$110 per barrel to an average of US$50 per barrel, caused
the fortunes of the Nigerian economy to nosedive sharply. The fall in the price of oil in mid-2014
affected oil producing countries and like most other oil producing countries, Nigeria secured its
foreign exchange to the US dollar by allowing its exchange rate to the dollar depreciate at the
expense of stock market performance.

Moreover, changes in the global price of oil oftentimes trickle down to stock prices in all
countries. Falling oil prices relate to shortage of foreign exchange earnings in the Nigerian
economy, thereby causing scarce and expensive foreign exchange rate. As a result of this,
thereby leading to foreign exchange rate depreciation and thereby causing fluctuations of stock
prices. For instance, foreign investors are busy investing their capital in stock market world over.
In this process international investment is booming rapidly and capital is moving across all over
the world. The benefits of these investors are being determined by foreign exchange. Also,
instability in the exchange rate may bring about uncertainty or otherwise in these investors. Thus,
exchange rate is important determinant of stock market fluctuations. Hence, there is expected to
be a linkage between oil price, exchange rate and stock prices in Nigeria and assessing the
linkage among these variables is fundamental in making economic and financial decisions by
investors, government and the private sector, which should be explored in this study.

In Nigeria, the value of naira experiences high degree of volatility. For example, statistical
records have shown that from 2006 to 2008 the value of naira to US$ was ₦125, but the trend
further depreciated from ₦150.3 in 2010 to average of ₦153.90, ₦156.81 and ₦305.25 per US$
in 2011,2013 and 2017, respectively. In the same vain, the stock market moves so strongly on the
same direction with the currency exchange rate. Statistically, stock market collapsed by about
70% between 2008 and 2009. Additionally, the All Share Index (ASI) are measure of stock
market performance has persistently declined from 65,652.38 in 2008 to less than 30,000.00
points in 2012. It however increases from 31,853.19 to 41,210.10 points between 2013 and 2014,
after which in continuously declined to less than 31,853.19 points from 2015 till 2017. In other
words, there is need to check and know the trend pattern of these variables in the scope of this
study.

Empirical investigations of the relationship of oil prices, exchange rate and stock prices have in
past been the concern of many economists especially in the developing economies of the world.
Even when economic theories postulate that changes in oil prices affect exchange rate directly
and indirectly on stock prices, through the influence of foreign exchange rate by affecting cash
flow, investment and profitability of firms, the empirical consensus is still indecisive. In what
follows, many empirical tests have been conducted in order to unveil the relationship of oil
prices, exchange rate variability and stock prices. However, the arrow of the relationship still
remains vague in both theory and empirics. In this study therefore, this study set to explore the
relationship of global oil prices, Naira-US$ exchange rate and stock prices in Nigeria in the
scope of this study.

According to Terfa .W. A(2016) showed that oil prices positively relates with the Nigerian
stock market performance thus, would drag the market down in times of turmoil.
Devaluation of the naira, however, was found to have been effective in cushioning the effect of
crude oil price decline on the performance of the Nigerian stock market. Thus, how oil prices
affect the stock market performance and exchange rate as also a contributing factor to this effect
is a major issue to be tackled in Nigeria it the course of this study, cause of their impacts on the
economy

According to Statistical Bulletin of OPEC (2010/2011), oil is the world’s most actively traded
commodity and the foreign exchange condition of countries with the endowment of oil are
susceptible to global oil price changes with larger percentage points. Nigeria is a net exporter of
oil and the country depends heavily on oil revenue for propelling the export revenues and foreign
exchange earnings. Nigeria is even dependent on the imports of some petroleum products due to
incapability of refining crude oil. By implication, changes in global oil price can have
relationship on the exchange rate of Nigeria directly through trade and indirectly on stock market
performance.

1.3 Research Questions

The following questions are imperative in analyzing the dynamic linkages among oil price
changes, exchange rate and stock prices in Nigeria.

i. What are the trends in international oil prices, exchange rate and stock prices in Nigeria from
1987 to 2018?

ii. What are the causal relationships that exist among oil price, domestic exchange rate and stock
prices in Nigeria ?

iii. What dynamic effects do global oil price changes have on the exchange rate and stock prices
in Nigeria?

iv Is there short run or long run relationship among the variables in the model ?

1.4 Objectives of the Study

The broad objective of this study is to investigate the relationship among oil price, exchange rate
and stock prices in Nigeria from 1987 to 2017. In line with this, the specific objectives are to:
 i. Analyze the trend in global oil prices, exchange rate and stock prices in Nigeria from
May, 1987 to December, 2017.
ii. Examine the causal relationships that exist among global oil price, exchange rate
and stock prices in Nigeria.
iii. Estimate the dynamic effects of global oil prices on exchange rate and stock prices
in Nigeria.
iv. Determine the short or long run relationship of the variables in the model

1.5 Justification of the Study

This study examines the relationship that exists among oil price, exchange rate and stock prices
in Nigeria. Although existing studies such as Osuji (2015), Ogundipe, et al., (2014), Salisu
(2017) have analyzed the direct impact of oil prices. Nancy, Estefanía and, Eduardo (2018),
Raheem, Aremu, Adebiyi and Musa (2016) analyzed dynamic effects of oil price shock and
exchange rate on the Nigeria stock market the effect of oil prices on exchange rate, applying
using vector autoregressive models. Oluwatomisin, Paul and Adeyemi (2014) examined the
effects of oil price, external reserves and interest rate on exchange rate volatility in Nigeria
applying Vector Error Correction Model. These studies fail to adopt a dynamic relationship for
oil price, exchange rate and stock prices in Nigeria under the same framework in that they only
measure the effect of oil prices on either exchange rate or stock prices and imply the effect of
the former on the latter, vice versa.

Furthermore, as for the relations among oil prices ,exchange rate and stock prices, Terfa (2016)
examined the effect of crude oil price movement on the Nigerian stock market and the role
of exchange rate as a plausible countercyclical policy tool using two periods: 2008-2009 and
2012-2015, applying Autoregressive Distributed Lag (ADL) model. This study being limited
in scope to adopt a dynamic relationship for oil price, exchange rate and stock prices in Nigeria.
Hence, in this study there is need to investigate the analysis of the relationship among oil prices,
exchange rate and stock prices in 1987 -2017.

In additional, Jain and Ghosh (2013), Jain and Biswal (2016), Qiming Li, et al., (2017) used only
the Brent Spot Price to proxy global oil price in studying dynamic relationship. In this study
however, both Brent and West Texas Intermediate (WTI) are used as proxies for global oil
prices. Also, this study extends the literature by adopting monthly time series data which helps to
account for robustness, seasonal and cyclical fluctuations in the data.

1.6 Scope and Limitation of the Study.

This study adopts secondary data which are global oil prices, exchange rate, and all share index.
Brent and West Texas Intermediate (WTI) which proxies global oil prices are obtained from
United States Energy Information Administration (EIA). Data on Exchange rate and Stock
prices are obtained from the Central Bank of Nigeria’s Statistical Bulletin and Nigerian Stock
Exchange (NSE). This study only covers Nigeria. All variables are logged for empirical analysis
in order to have a uniform unit of measurement to allow for easy and comprehensible trend
analysis of the variables. The major limitation of this study is the unavailability of monthly data
series for Brent and WTI from 1970 to 1986. Hence, this study adopts data on a monthly basis
from May, 1987 to December, 2017.

1.7 Plan of the Study

This study is divided into five chapters which include the introduction, literature review
and theoretical framework, research methodology, empirical analysis, summary, conclusion and
policy recommendations.

The chapter one consists of the background to the study, problem statement, research questions,
and objectives of the study, justification of the study, significance of the study scope and
limitation of the study and in addition, plan of the study. The chapter two consists of the
literature review and theoretical framework which are subdivided into conceptual
framework, methodological review, and empirical review. In this chapter, definitions and
linkages of concepts relating to the study are discussed in [Link] chapter three simply
describes the data and variables, as well as various methods used in research. The chapter
four presents and discusses various estimation results. In this chapter, results of this study are
also compared with that of existing studies. The chapter five summarizes major findings and
concludes the study.
REFERENCES

Anyawu, J., Oyefusi. A., Oaikhenan, H., and Dimowo, F. (1997). The Structure of the Nigeria
Economy (1960-1997), Joanee Educational Publishers Ltd, Onitsha

Aremu R., and Musa A., (2016). Analysis of the relationship between Oil price, Exchange rate
and Stock market in Nigeria, MPRA Paper No. 73549, Pp. 1-15.

Bala S., Hassan A., (2018). Exchange rate and Stock Market Interactions: Evidence from
Nigeria, Arab Journal Bus Manage Rev 2017, Vol 8(1): 334.

Basher, S. A., Haug, A. A. and Sadorsky, P. (2010). Oil Prices, Exchange Rates and
Emerging Stock Markets. University of Otago Economics Discussion Papers No. 1014
(September)

Basher, S. A., Haug, A. A., and Sadorsky, P. (2012). Oil prices, exchange rates and emerging
stock markets. Energy Economics, 34(1), 227–240.

Eryiğit, M. (2012). The Dynamical Relationship between Oil Price shocks and Selected
Macroeconomic Variables in Turkey. Economic Research (Ekonomska istraživanja), 25
(2): 263-276.

Imarhiagbe, S. (2010). Impact of Oil Prices on Stock Markets: Empirical Evidence from
Selected Major Oil Producing and Consuming Countries. Global Journal of Finance
and Banking Issues 4 (4): 15 -31

Kumar, M. (2014). The Impact of Oil Price Shocks on Indian Stock and Foreign
Exchange Markets. ICRA Bulletin Money and Finance (February), pp 57 – 88

Jain A., and Biswal P.C., (2016). Dynamic linkages among oil price, gold price, exchange rate,
and stock market in India, Resource Policy Journal, Vol. 49, Pp. 179-185.

Jain A., and Ghosh S., (2013). Dynamics of global oil prices, exchange rate and precious metal
prices in India, Resource Policy Journal, Vol. 38, Pp. 88-93.
Le, T., and Chang, Y. (2011). The Impact of Oil Price Fluctuations on Stock Markets in
Developed and Emerging Economies. Economic Growth Centre (EGC) Working Paper
Series No. 2011/03.

Peterside, T. (2012). Assessing the Importance of Nigeria’s National Stock Exchange for
Economic Growth and Capital Market Development. A paper presented at the bonds and
loans Africa conference, Cape Town, 14 March

Terfa, W. (2016). Exchange Rate Policy and Falling Crude oil Prices: Effect on the Nigerian
Stock Market, Central Bank of Nigeria Journal of Applied Statistics Vol. 7 No. 1(a), Pp.
1-13.