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MF
40,2
200
Received 8 June 2013
Revised 14 August 2013
4 October 2013
Accepted 6 October 2013
Managerial Finance
Vol. 40 No. 2, 2014
pp. 200-215
q Emerald Group Publishing Limited
0307-4358
DOI 10.1108/MF-06-2013-0131
An empirical study on the
dynamic relationship between oil
prices and Indian stock market
Tarak Nath Sahu and Kalpataru Bandopadhyay
Department of Commerce with Farm Management,
Vidyasagar University, Midnapore, India, and
Debasish Mondal
Department of Economics with Rural Development,
Vidyasagar University, Midnapore, India
Abstract
Purpose – This study aims to investigate the dynamic relationships between oil price shocks and
Indian stock market.
Design/methodology/approach – The study used daily data for the period starting from
January 2001 to March 2013. In this study, Johansen’s cointegration test, vector error correction
model (VECM), Granger causality test, impulse response functions (IRFs) and variance
decompositions (VDCs) test have been applied to exhibit the long-run and short-run relationship
between them.
Findings – The cointegration result indicates the existence of long-term relationship. Further, the
error correction term of VECM shows a long-run causality moves from Indian stock market to oil price
but not the vice versa. The results of the Granger causality test under the VECM framework confirm
that no short-run causality between the variables exists. The VDCs analysis revealed that the Indian
stock markets and crude oil prices are strongly exogenous. Finally, from the IRFs, analysis revealed
that a positive shock in oil price has a small but persistence and growing positive impact on Indian
stock markets in short run.
Originality/value – The study would enhance the understandings of the interaction between oil
price volatilities and emerging stock market performances. Further, the study would enable foreign
investors who are interested in Indian stock market helps in understanding the conditional
relationship between the variables.
Keywords Cointegration, Stock market, Granger causality test, Crude oil price
Paper type Research paper
1. An overview
1.1 Introduction
The surge in oil prices over the past few years has generated a lot of interest in the
relationship between oil prices and financial markets. Due to its crucial role in the
economy, movements in oil prices receive a special attention in daily media. A small
change in oil price has effects on almost all economic variables. Liberalization of many
emerging economies and integration of international markets characterized with
increased level of capital flows and international investments have made the global
investors more vulnerable to emerging stock markets due to its relation with oil
JEL classification – C32, E31, E44, G14
price fluctuation. Changes in the price of crude oil are often considered an important Empirical study
factor for understanding fluctuations in stock prices and vice versa. On theoretical grounds, on dynamic
oil price shocks affect stock market prices or returns through their effect on expected
earnings (Jones and Kaul, 1996). Understanding the relationship between oil prices and relationship
stock market prices in an emerging economy like India is an important topic to study
because the emerging economies continue to grow and prosper and they are expected
to exert a larger influence over the global economy. However, the nature of interaction 201
may vary according to the country examined and the prevailing economic condition.

1.2 An overview of the existing literature

From an empirical perspective, a substantial academic and professional literature,
especially in the developed countries like the USA, Australia, etc. explores the
interaction between crude oil price and stock market performance. The response of
aggregate real stock returns is either mainly positive or negative, depending on
whether the increase in crude oil price is driven by demand shocks or supply shocks in
the crude oil market. Further, the rise in oil prices may have adverse effects on
emerging market economies that has no oil production facilities while there may have
positive effects on emerging market economies that produce oil.
Literature explaining a negative relationship between oil price and stock prices. There
are several theoretical mechanisms describing the negative relationship between oil
price and stock market movement. In a microeconomic view, rising oil prices adversely
affect earnings of those companies for which oil is a direct or indirect cost of production.
If the firms cannot fully pass this increased cost to their consumers, the firms’ profits
and dividends which are key drivers of stock prices will decline (Al-Fayoumi, 2009). The
effect is immediate or lagged depending on the efficiency of the stock market. Moreover,
non-oil-producing countries have to bear the rising costs and face with increasing risk
and uncertainty caused by oil price volatility which negatively affects stock prices.
Again, oil price hikes is often thought to bring inflationary pressures, which urge
central banks and policy makers to control inflation by raising interest rate. In the
equity pricing model, the equity price equals to the expected present value of future cash
flows. Therefore, the rising interest rate has a direct impact on the discount rate in this
equity pricing formula, which leads to a decline in stock prices. The negative effect of
rising oil prices on stock markets has been supported by a number of researches. Jones
and Kaul (1996) have concluded that the US, Canadian, UK and Japanese stock prices
are negatively associated with oil price shocks. Valadkhani et al. (2009) analyses the
effect of various international stock market price indices and some relevant
macroeconomic variables on the Thai stock market price index, using a GARCH-M
model during 1988-2004. They find that changes in the price of crude oil negatively
affect the Thai stock market in the pre-Asian crisis period. In a study, Filis (2010)
demonstrates that oil prices have a significant negative impact on Greece stock market.
In conformity with the earlier studies Miller and Ratti (2009) and Basher et al. (2012) also
conclude that a positive shock to oil price tend to depress the stock prices of emerging
economies.
Literature explaining a positive relationship between oil price and stock prices. The
stock price might be positively related with oil price due to several reasons. At the time
of worldwide boom or at the time when economy recovers from recession, the global
demand picks up and it leads to the rise of basic material prices like crude oil.
MF Besides, if the stock market of a developing economy is cointegrated with the stock
40,2 markets of developed countries, then the joint effect might magnify the result
significantly. An increase in oil price is expected to have a positive impact on stock
markets in oil-exporting countries, through income and wealth effects. This is due to a
rise in government revenues and public expenditure on infrastructure and other omega
projects (Al-Fayoumi, 2009). Moreover, higher oil price represents an immediate
202 transfer of wealth from net oil importers to net oil exporters. The length of the effect
depends on where the government of oil exporters put the resulting additional income.
If the income is used to purchase goods and services domestically, the resulting effect
is generation of a higher level of economic activity and improvement of stock market
returns in those countries. In addition, increase in oil volatility may increase the
speculations which might raise the stock returns. This positive relationship between
the oil prices and stock prices is supported by Sadorsky (2001). Using a multifactor
market model he demonstrates that stock returns of Canadian oil and gas companies
are positive and sensitive to oil price increases. In particular, an increase in the oil price
leads to an increase in the returns of Canadian oil and gas stocks. Similarly, Boyer and
Filion (2004) find a positive association between energy stock returns and the prices of
oil and gases. Beside the above studies Hammoudeh and Li (2005) also conclude the
same thing that the oil price growth leads the stock returns of oil-exporting countries
and oil-sensitive industries in the USA. In the line of the previous three studies
Sahu et al. (2012) concludes that there exist a long-term co-movements among the crude
oil prices and the Indian stock markets. Their study shows a long-run causality
movement from Indian stock market to oil prices and the results of the Granger
causality test also confirm the same unidirectional movement in the short run.
Beside the above studies Krugman (1983) examines the short- and long-run effects
of oil price shocks in three different countries namely the USA, Germany and OPEC
using partial equilibrium balance of payment model. His study establishes that an oil
price shock affects major variables in all three countries. Amano and Van Norden
(1998) find a robust and interesting relationship between the real domestic price of oil
and real effective exchange rates for Germany, Japan and the USA. Employing
Johansen-Juselius cointegration test, they found that all the three currencies are
cointegrated with the oil price which suggest that the price of oil capture the permanent
innovations in the real exchange rate of all the three countries. Anoruo (2010) provides
an evidence of bidirectional causality between change of crude oil price and stock
market returns. Similarly Kapusuzoglu (2011) and Hosseini et al. (2011) conclude that
there exists a strong linkage between oil price shock and stock market return in both
long and short run. In line with earlier studies Chittedi (2012) investigates the long-run
relationship between oil prices and stock prices for India over the period April
2000-June 2011. For this purpose, he employs autoregressive distributed lag model that
takes into account both the short- and long-run relationships. The study suggests that
the volatility of stock prices in India have a significant impact on the volatility of oil
prices. But a change in the oil prices does not have impact on stock prices.
Raheman et al. (2012) have conducted a study to determine the relationship between oil
price fluctuations and stock returns of the Asia Pacific countries. They found a
significant short run relationship between oil price fluctuations and stock returns for
Asia Pacific countries. Granger causality test revealed that oil price is a Granger cause
of stock returns for only Pakistan and Sri Lanka. Yoshizaki and Hamori (2013)
investigate the effects of oil price shocks on production, price level, and exchange rate Empirical study
of eight important industrialized countries. They find that the oil price shocks have on dynamic
significant effect on exchange rates. Nakajima and Hamori (2012) have tested the
Granger causality-in-mean and Granger causality-in-variance among electricity prices, relationship
crude oil prices, and exchange rates in Japan using a cross-correlation function
approach. They conclude that the individual effect of exchange rates and oil prices are
not significant to influence the power sector, however, the joint effect of them greatly 203
influence the power generation costs in Japan. Similarly, Toraman et al. (2011),
Muritala et al. (2012) and Sharma and Khanna (2012) also conclude that there exist a
significant long-term relationship between stock market indices and oil price. But
Cong et al. (2008) and Sehgal and Kapur (2012) do not support the hypothesis that oil
price shocks have a significant impact on the real stock returns.
From the earlier studies we observe that the studies on the relationship between oil
price volatility and stock market movement has been extensive for many developed
countries. However, the available research into this phenomenon is limited with respect
to the emerging economies like India. In India after the liberalization, the regulatory
authorities are creating a different economic environment under which the companies
are performing now. In most of the cases, financial performances of the companies are
found to be affected by the new environment. Thus, it is worth to carry out studies on
emerging economy which have become increasingly attractive destination for huge
amounts of capital movement from major economies. “In this backdrop, our present
study attempts to investigate empirically the dynamic relationship between crude oil
price and Indian stock market”. The rest of the paper is organized into four sub
sections. Section 2 discusses the data and methodology used in the study, i.e. the
research design. While Section 3 presents the findings; Section 4 summarizes and
interprets the results and finally, Section 5 concludes the study.

2. Research design
2.1 Data
Data set used in this study encompasses the period starting from January 2001 to
March 2013 and analyses have been performed by using 2,852 data on daily basis.
Closing data pertaining to BSE Sensex and S&P CNX Nifty Index are collected from
the respective web site of Bombay Stock Exchange and National Stock Exchange, and
Crude oil price data are obtained from Bloomberg database and Ministry of Petroleum,
Government of India. Microsoft Office Excel 2007 and Eviews-7 package are used for
econometric analyses (Figure 1).

2.2 Methodology
Given the nature of the problem and the quantum of data, we first study the data
properties from an econometric perspective with the help of descriptive statistics and
unit root test. This would help us applying cointegration test, vector error correction
model (VECM), variance decomposition test and impulse response analysis to establish
the long-run equilibrium relationship and the short-run dynamics among the variables
and Granger causality test for evaluating the direction of causality.
Unit root test. A series, regarded as a stationary series which does not have any unit
root property. In case of non-stationary time series, there is a possibility of
encountering with fake regression problem. In this case, the result obtained by
MF 24,000
40,2 20,000
16,000
12,000
8,000
204 4,000
0
Figure 1. 02 04 06 08 10 12
Graphical representation
SENSEX NIFTY CP
of Sensex, Nifty and crude
oil price (CP)

regression analysis does not reflect the real relationship. The commonly used
augmented Dickey-Fuller (ADF) and Phillips-Perron (PP) unit root tests are applied to
determine the variables’ stationarity properties and order of integration of the
variables.
Johansen’s cointegration test. The cointegrating regressions are calculated using
Johansen’s cointegration approach to know the long-run equilibrium relationship
among the variables. The concept of cointegration becomes completes relevant when
the time series being analysed are non-stationery. In econometric terms, two variables
are said to be cointegrated if they have a long term or equilibrium relationship between
them. Appropriately, the test provides us information on whether the variables,
particularly the crude oil price and the Indian stock market indices are tied together in
the long run or not.
Vector error correction model. There often exists a long-run equilibrium relation
between two or more variables but in the short run there may be disequilibrium. If the
variables are found to be cointegrated then we employ VECM to identify the existence
of any disequilibrium in short run and the rate of correction to attain the long-term
equilibrium relationship among them. According to Engle and Granger (1987) if a
number of variables are found to be cointegrated, there always exists a corresponding
error correction representation in which the short-run dynamics of the variables in the
system are influenced to deviate the equilibrium relationship. The VECM shows that
change in the dependent variables is a function of the level of disequilibrium in the
cointegrating relationship captured by the error correction term, as well as changes in
other explanatory variables. With the error correction mechanism, a proportion of the
disequilibrium in one period is corrected in the next period. The error correction
procedure is hence a way to reconcile short- and long-run behavior through a series of
partial short-run adjustments.
Granger causality test. The causality test can be conducted in two different ways
depending on the results of the long-run analysis. The Granger test (Granger, 1969) is
suitable for analyzing the short-run relationship if no cointegration exists among the
variables. On the other hand, when the variables are cointegrated, the standard
Granger test is misspecified and the error correction strategy suggested by Engle and
Granger (1987) should be used to identify the long- and short-term causal relationship
among the variables. The VECM implies that changes in one variable are a function of
the level of disequilibrium in the cointegrating relationship (captured by the error Empirical study
correction term), as well as, changes in other explanatory variables. Thus, the VECM is on dynamic
useful for detecting the long- and short-term causality when the variables are
cointegrated. The VECM can distinguish between the short- and long-run causality relationship
because it can capture both the short-run dynamics between the time series and their
long-run equilibrium relation. The error correction terms capture the long-run
relationships among variables and the causality is tested through the significance of 205
the t-test of the error correction term which contains the long-term information, as it is
derived from the long-term cointegrating relationship. On the other hand, the short-run
causality is tested by the joint significance of the coefficients of the differenced
explanatory variables by using the F-statistics or x 2-test statistics.
Variance decompositions test (VDCs) and impulse response analysis (IRFs).
Despite the importance of conducting causality tests, the empirical inferences based on
the causality test do not determine the strength of the causal relationships between the
variables nor do they describe the relationship between these variables over time.
Variance decomposition test is used to explore the degree of exogeneity of the variables
involved in this study. It illustrates the share of the forecast error of one variable as a
result of changes in the other variables. Hence, the relative significance of each variable
can be determined which causes oscillations in the other variable. Similarly,
the empirical inferences based on the Granger causality test helps to qualify the flow of
influences but the estimates of the impulse response analysis can give us a quantitative
idea about the impacts for several periods in future. The estimated impulse response of
the VAR system enables us to examine how each of the variables responds to
innovations from other variables in the system. More specifically IRFs essentially map
out the dynamic response path of a variable due to a one standard deviation shock to
another variable.

3. Findings of the study

3.1 Findings from the descriptive statistics
The basic statistical values of the variables are calculated in the first phase of our
study. From Table I, it is observed that the crude oil prices as well as the value of
Sensex and Nifty are not stable at all during the study period. In respect of oil price the
maximum value of 6,291.92 and minimum value of 840.35 are found with an average of
2,928.95, which justify their instability. The value of standard deviation in this regard

Statistics BSE Sensex S&P CNX Nifty Crude oil price

Mean 11,206.64 3,382.50 2,928.95

Median 11,789.86 3,480.88 2,814.27
Maximum 20,932.48 6,301.55 6,291.92
Minimum 2,600.12 854.20 840.35
SD 6,014.53 1,769.94 1,325.81
Skewness 2 0.05 20.02 0.31
Kurtosis 1.43 1.46 2.02
Jarque-Bera statistics 293.46 282.98 161.62
Probability 0.000000 0.000000 0.000000 Table I.
Total no. of observation 2,852 2,852 2,852 Descriptive statistics
MF also shows the instability of daily oil price. During the study period the value of Sensex
40,2 and Nifty are also found to vary significantly. The high differences between maximum
value and minimum value reveal that the values of these variables are also highly
unstable during this period. From the result it can be said that variables are not
distributed normally, but the median values of variables are very close to average
values. Again, the measures of skewness suggest that the variables are not distributed
206 symmetrically. From Table I it is clear that stock market indices of India are negatively
skewed while the oil prices skewed positively. The kurtosis indicates that all the
selected series are less peaked than normal distribution, i.e. they follow platykurtic
distribution. Results obtained from Jarque-Bera statistic confirm that none of the series
are normally distributed. The null hypotheses of Jarque-Bera test (data follow normal
distribution) are rejected in all the cases at 1 percent level of significance.

3.2 Findings from long-run analysis

As mentioned before, the long-run analysis is conducted using the Johansen
cointegration test. Typically, the Johansen cointegration test consists of three general
steps. First, examine whether all variables in the model are integrated of the same
order, which can be established by unit root tests. Second, determine the optimal lag
length for the VAR model to verify that the estimated residuals are not autocorrelated.
Third, estimate the VAR model to construct the cointegration vectors in order to
determine the order of cointegration that is necessary to establish the trace and the
max-eigen value statistics tests. The following subsections present the results for each
step.
Results of unit root test. Results of unit root test applied in the levels are presented in
Table II. When Table II is examined, it is observed that all the variables are
non-stationary, i.e. they have unit roots in both the models (constant and
constant-trend) in ADF and PP tests as the test statistics of ADF and PP test
cannot reject the null hypothesis (the series contain unit root) at 5 percent level of
significance. As both the variables are non-stationary at their levels, relevant variables
are tested again for unit roots by taking their first differences. The results are shown in
Table III and it is observed that all the variables are stationary in their first differences,
i.e. the variables are integrated of order one.
Selection of optimum lag length. As the autoregressive model is sensitive to the
selection of appropriate lag length, the study is to ascertain the appropriate lag length
before conducting the cointegration analysis in line with Johansen. The study has
determined the optimum lag length based on the Akaike information criteria (AIC),

ADF test statistics PP test statistics

Variables Intercept Trend and intercept Intercept Trend and intercept

BSE Sensex 20.8344 [0] 22.3690 [0] 2 0.8568 [1] 2 2.4421 [4]
(0.8087) (0.3958) (0.8021) (0.3575)
S&P CNX Nifty 20.8415 [0] 22.5485 [0] 2 0.8563 [5] 2 2.5778 [7]
(0.8066) (0.3045) (0.8022) (0.2907)
Crude oil price 21.1024 [1] 23.2047 [1] 2 1.1256 [11] 2 3.2888 [7]
Table II. (0.7171) (0.0836) (0.7078) (0.0683)
Result of ADF and PP
unit root test (in level) Notes: ( ) MacKinnon (1996) one-sided p-values; [ ] lag lengths for ADF and PP test
Schwarz information criteria (SIC) or Hannan-Quinn information criteria (HQC). The Empirical study
results are provided in Table IV. The AIC criteria suggested a higher lag length, i.e. 7 on dynamic
and SIC criteria suggested a lower lag length of 1. We could not take the risk of over
parameterization or under parameterization by considering too higher lags or too lower relationship
lag. Therefore, the study chose HQC criteria for optimum lag length selection and the
optimum lag length is 2, having the minimum HQC value.
Results of Johansen cointegration test. The calculated values of trace statistics 207
(presented in Table V) for oil price and Sensex and oil price and Nifty, when the null
hypothesis is r ¼ 0 (i.e. no cointegration), are 17.49 and 17.93, respectively, and
maximum eigen statistics (presented in Table VI) are 16.34 and 16.81, respectively. Here,
the null hypothesis of no cointegration when r ¼ 0, is rejected at the 5 percent level of
significance, as the calculated value of trace statistics and maximum eigen statistics are
higher than the MacKinnon-Haug-Michelis critical value at 5 percent level of
significance. This indicates that there exists one cointegrating vector for each case. So
the Johansen’s test result support the hypothesis that crude oil price and stock indices
(Sensex and Nifty) are cointegrated and there exist one cointegrating relationship
between the relevant variables in each case. The long-run cointegrating equations are:

ADF test statistics PP test statistics

Variables Intercept Trend and intercept Intercept Trend and intercept

BSE Sensex 250.8586 [0] 250.8498 [0] 250.8714 [2] 2 50.8626 [2]
(0.0001) (0.0000) (0.0001) (0.0000)
S&P CNX Nifty 251.7785 [0] 251.7696 [0] 251.7825 [3] 2 51.7737 [3]
(0.0001) (0.0000) (0.0001) (0.0000)
Crude oil price 256.9782 [0] 256.9704 [0] 256.9753 [9] 2 56.9679 [9] Table III.
(0.0001) (0.0000) (0.0001) (0.0000) Result of ADF and PP
unit root test (in first
Notes: ( ) MacKinnon (1996) one-sided p-values; [ ] lag lengths for ADF and PP test difference)

AIC SIC HQC

Lag length SEN and CP NIF and CP SEN and CP NIF and CP SEN and CP NIF and CP

0 35.96067 33.48139 35.96486 33.48558 35.96218 33.48291

1 24.85346 22.47291 24.86603a 22.48547a 24.85799 22.47823
2 24.84945 22.47067 24.87039 22.49162 24.85700a 22.47744a
3 24.85174 22.47253 24.88106 22.50185 24.86232 22.48310
4 24.84894 22.47021 24.88664 22.50791 24.86254 22.48381
5 24.85090 22.47240 24.89698 22.51847 24.86752 22.48901
6 24.84806 22.46937 24.90252 22.52382 24.86771 22.48901
7 24.84674a 22.46860a 24.90957 22.53144 24.86941 22.49127
8 24.84886 22.47027 24.92007 22.54147 24.87455 22.49595
9 24.84976 22.47145 24.92934 22.55104 24.87846 22.50016
10 24.85121 22.47302 24.93917 22.56098 24.88294 22.50474
Notes: aThe optimum lag order selected by the criterion; AIC – Akaike information criterion, SIC – Table IV.
Schwarz information criterion, HQC – Hannan-Quinn information criterion (Sensex, Nifty and crude VAR lag order selection
oil price are represented as SEN, NIF and CP, respectively) criteria
MF SENt ¼ 22417:84 þ 4:65 CPtð8:42Þ þ ut NIFt ¼ 2615:09 þ 1:36 CPtð8:68Þ þ ut
40,2 Based on the above cointegrating equations, the study concludes that, the long-term
impacts of Sensex and Nifty on crude oil price are positive and significant (on the basis of
t-test statistics), i.e. they move together in the same direction.

208 3.3 Findings from short-run analysis

Having established that both the stock indices and crude oil price are cointegrated, the
fundamental question that arises regarding the nature of the relationship between
these variables in the short run can be answered by considering the error correction
mechanism.
Result of the vector error correction mechanism. Table VII presents the results of the
VECM. The t-values associated with the lag value of the oil price are not significant

Model H0 H1 Trace statistics 5% critical value

BSE Sensex and crude oil price r¼0 r¼1 17.4920 * (0.0247) 15.4947
r#1 r¼2 1.1539 (0.2827) 3.8415
S&P CNX Nifty and crude oil price r¼0 r¼1 17.9317 * (0.0211) 15.4947
r#1 r¼2 1.1206 (0.2898) 3.8415
Table V. Notes: Statistically significant at: *5 percent level; ( ) MacKinnon-Haug-Michelis (1999) p-values
Results of cointegration (H0 and H1 are the null and alternative hypotheses, respectively, and r is the number of cointegrating
test (trace statistics) vector)

Maximum eigen
Model H0 H1 statistics 5% critical value

BSE Sensex and crude oil price r¼0 r¼1 16.3382 * (0.0232) 14.2646
r#1 r¼2 1.1539 (0.2827) 3.8415
Table VI. S&P CNX Nifty and crude oil price r¼0 r¼1 16.8111 * (0.0194) 14.2646
Results of cointegration r#1 r¼2 1.1206 (0.2898) 3.8415
test (maximum eigen
statistics) Notes: Statistically significant at: *5 percent level; ( ) MacKinnon-Haug-Michelis (1999) p-values

Dependent variables Independent variables

ECT (g1) D(CP(2 1)) D(SEN(21))

D(SEN) 0.0012 [0.9286] 20.0788 [2 1.5419] 0.0517 * * [2.7151]
D(CP) 20.0087 * * [24.0356] 20.0633 * * [2 3.3486] 2 0.0002 [20.0334]
ECT(g2) D(CP(2 1)) D(NIF(21))
D(NIF) 0.0012 [0.8733] 20.0146 [2 0.9374] 0.0318 * [1.6734]
D(CP) 20.0090 * * [24.0968] 20.0642 * * [2 3.3966] 0.0060 [0.2587]
Notes: Statistically significant at: *10 and * *1 percent levels; [ ] t-values (Sensex, Nifty and crude
Table VII. oil price are represented as SEN, NIF and CP, respectively, and the error correction term is represented
Results of VECM as ECT)
when Sensex or Nifty is used as a dependent variable, which demonstrate that the Empirical study
Indian stock market does not depend on the value of oil price in short run. The result on dynamic
also exhibits that, in short run the oil price is not affected by the value of Sensex and
Nifty. The Indian stock market and the oil prices are mainly exogenous in nature they relationship
mostly depend on the past value of its own.
Moreover, the VECM results indicate that oil prices adjust the disturbances to
restore long-run equilibrium significantly and in right direction, but the Sensex and 209
Nifty do not react significantly. The coefficients of error correction term 2 0.0087 and
2 0.0090 of Sensex and Nifty, respectively, which are significant at 1 percent level of
significance tell us the rate at which they correct the disequilibrium of the previous
period. Thus, speeds of adjustment towards the long-run equilibrium are about
0.87 and 0.90 percent per day for Sensex and Nifty, respectively.

3.4 Result of the causality test

The result of the long- and the short-run causality test under VECM framework are
reported below.
Long-run causality test. The t-values associated with the error correction terms of
VECM, reported in Table VII, indicate that the price of crude oil have no significant
long-run causal effect on Indian stock market. The result shows a unidirectional
long-run causal effect runs from stock market indices to crude oil price as the
coefficients of the error correction term, having Sensex and Nifty in the model, are
2 0.0087 and 2 0.0090 statistically significant at 1 percent level.
Short-run causality test. The results of short-run causality test among the variables
based on Wald test are presented in Table VIII. According to the obtained results, it
can be said that there does not exist any short-run causal relationship among the stock
market indices and crude oil prices as the x 2-test statistics are not statistically
significant.

3.5 Results of variance decompositions test and impulse response functions analysis
The study has estimated the impulse response functions and variance decompositions
under the VECM framework to investigate the dynamic relationship of Indian stock
indices with crude oil price.
Tables IX and X indicate that Sensex and Nifty are strongly exogenous because
almost 99.74 and 99.83 percent of its own variance is explained by its own shock even
after 30 days while the percentage of the foreign explanatory power (CP) on Indian
stock markets, is found insignificant, reaching the highest value of 0.26 percent at time
length of 30 days. So a very small portion of the forecast error variance of stock indices
is explained by the crude oil prices. This is due to the fact that, during the study period,
stock prices are more dependent on themselves than on the oil price. The results also

Dependent Independent Probability

Model variables variables x 2-value value Implication
Table VIII.
1 Sensex Crude oil price 2.3775 0.1231 No causality VEC Granger
Crude oil price Sensex 0.0011 0.9733 No causality causality/block
2 Nifty Crude oil price 0.7958 0.3486 No causality exogeneity Wald test
Crude oil price Nifty 0.0670 0.8786 No causality results
MF Percentage of forecast error variance
40,2 explained by innovation in:
Variance decompositions of Period Sensex Crude oil price

Sensex 1 100.00 0.00

5 99.92 0.08
10 99.88 0.12
210 15 99.85 0.15
20 99.82 0.18
25 99.78 0.22
30 99.74 0.26
Crude oil price 1 2.65 97.35
5 2.98 97.02
10 3.46 96.54
Table IX. 15 3.99 96.01
Variance decomposition 20 4.56 95.44
of Sensex and crude oil 25 5.19 94.81
price 30 5.85 94.15

Percentage of forecast error variance

explained by innovation in:
Variance decompositions of Period Nifty Crude oil price

Nifty 1 100.00 0.00

5 99.96 0.04
10 99.94 0.06
15 99.92 0.08
20 99.89 0.11
25 99.86 0.14
30 99.83 0.17
Crude oil price 1 2.48 97.52
5 2.98 97.02
10 3.50 96.50
Table X. 15 4.07 95.93
Variance decomposition 20 4.69 95.31
of Nifty and crude oil 25 5.35 94.65
price 30 6.06 93.94

indicate that oil prices are comparatively less exogenous than the Indian stock market
in the sense that the percentage of the error variance of oil prices accounted by its own
is approximately 94 percent at time horizon of 30 days.
The results of the impulse response analysis for a time horizon of 30 days to one
standard deviation shock in Sensex and oil prices are shown in Tables XI and the path
in Figure 2. Table XII and Figure 3 summarizes the impulse responses of Nifty to one
standard deviation shock in oil price and vice versa for the next 30 days. The responses
generated from a positive shock on oil prices are very small but it has persistence and
increasing effect on Indian stock markets. The responses are positive for both the stock
indices.
 Impulse responses
Empirical study
One standard deviation shock in the variable Period Sensex Crude oil price on dynamic
Sensex 1 199.30 0.00 relationship
5 209.89 2 7.13
10 210.71 2 8.81
15 211.50 210.44
20 212.26 212.01
211
25 212.99 213.53
30 213.70 214.99
Crude oil price 1 12.01 72.80
5 12.34 66.13
10 13.67 63.38 Table XI.
15 14.96 60.73 Impulse responses of
20 16.20 58.17 Sensex and crude oil price
25 17.39 55.70 to one standard deviation
30 18.54 53.32 shock in the variables

Response to Cholesky One S.D. Innovations

Response of SENSEX to SENSEX Response of SENSEX to CP
250 250
200 200
150 150
100 100
50 50
0 0
–50 –50
5 10 15 20 25 30 5 10 15 20 25 30
Response of CP to SENSEX Response of CP to CP
80 80
70 70
60 60
Figure 2.
50 50
Impulse responses of
40 40 Sensex and crude oil price
30 30 (CP) to one standard
20 20 deviation shock in the
10 10 variables
5 10 15 20 25 30 5 10 15 20 25 30

4. Summary of the results and its interpretation

In line with the earlier findings made by Sadorsky (2001), Boyer and Filion (2004),
Sahu et al. (2012), etc. our present study based on Johansen’s cointegration test
confirms the existence of a significant positive long-run relationship between oil price
and stock indices. However, the causality test based on VECM framework indicates
that the prices of crude oil have no significant long-run causal effect on Indian stock
market. Moreover, the results obtained from Granger causality test confirm that no
causal relationship exist among oil price and Indian stock indices in short run.
MF
Impulse responses
40,2 One standard deviation shock in the variable Period Nifty Crude oil price

Nifty 1 60.62 0.00

5 62.65 2 1.45
10 62.90 2 1.95
212 15 63.14 2 2.43
20 63.37 2 2.90
25 63.60 2 3.34
30 63.81 2 3.77
Crude oil price 1 11.62 72.85
5 12.44 66.06
Table XII. 10 13.84 63.24
Impulse responses of 15 15.19 60.53
Nifty and crude oil price 20 16.49 57.92
to one standard deviation 25 17.75 55.41
shock in the variables 30 18.96 52.98

Response to Cholesky One S.D. Innovations

Response of NIFTY to NIFTY Response of NIFTY to CP
80 80
60 60
40 40
20 20
0 0
–20 –20
5 10 15 20 25 30 5 10 15 20 25 30
Response of CP to NIFTY Response of CP to CP
80 80
70 70
60 60
50 50
Figure 3. 40 40
Impulse responses of Nifty
30 30
and crude oil price (CP) to
one standard deviation 20 20
shock in the variables 10 10
5 10 15 20 25 30 5 10 15 20 25 30

The positive movement of Indian stock market is an indication of better performance of

the company, which mainly due to higher consumption as well as higher production of
goods and services. The high level of production increases the demand of oil which
leads to increase the prices of oil. Moreover, the international price of crude oil (WTI)
per barrel has risen from $27.29 in January 2001 to $97.24 in March 2013 with a
maximum of $113.39 on 29 April 2011 in our study period. As Indian economy is
controlled one and as the oil price is subsidized in India, So the rise in international
crude oil prices may not contribute any significant impact on the production cost as Empirical study
well as the profitability of Indian companies. In addition to that, during the study on dynamic
period India has significantly improved the income generation rate which leads to
economic development of the country. As long as the growth of income remains robust relationship
enough, higher inflation and a subsequent rise of interest rates may not affect the
overall consumption trend adversely.
213
5. Conclusion
The study concludes that there exist a positive long-run relationship between oil prices
and the movement of stock market indices, though the prices of crude oil have no
significant causal effect on Indian stock market. Evidence of this study provides a
comprehensive understanding on the dynamic relationship between oil price and stock
market in India. It discusses the theoretical hypotheses on this captioned relationship
and compares with empirical evidences from prior research. The study extends the
literature by examining the relationship in the emerging market, the Indian economy.
This study is expected to offer some insights for financial regulators and policymakers
for formulating economic and financial policies. Policymakers are mainly interested in
exploring the determinants of the stock market, and how stock market movements
affect the real economic activity. The sense of this inter-relationship is also useful to
shareholders and portfolio managers as it provides a better understanding of portfolio
structure and evaluation to improve overall portfolio design and performance. Further,
the study would enable foreign investors who are interested in Indian stock market
helps in understanding the conditional relationship between the variables.
This study also suggests some future research to enhance our understanding on this
issue. The possible extension of this study is to consider the impact of oil price along
with the other important macroeconomic determinant which might jointly influence the
Indian stock market. Instead of using only the quantitative macroeconomic variables
the study suggests the inclusion of socio-economic and political factors as dummy
variables on these grounds. Further study could empirically test the relationship by
considering the potential structural breaks. Moreover, since the long-run relationship
between oil price and stock prices is expected to vary from one industry to another, a
sectoral analysis of the matter would be more informative. But, this is beyond the aim of
this present study. It is left for further research.

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Corresponding author
Tarak Nath Sahu can be contacted at: taraknathsahu1@rediffmail.com

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