1.

1 Stock Market Volatility

Stock market volatility is an integral part of the market system. Volatility in the stock market
is a phenomenon that is closely tracked by practitioners and academicians alike. In simple
terms, volatility is a statistical measure of the degree of fluctuation in trading prices of stocks
and other financial instruments observed in a particular time period. Volatility directly
impacts the level of expected market returns by causing variability in realized returns and as a
result, several financial products, portfolios, theories, and tools are built around limiting or
harnessing such volatility. A variable’s volatility, σ, is defined as the standard deviation of
the return provided by the variable per unit of time when the return is expressed using
continuous compounding. When volatility is used for option pricing, the unit of time is
usually one year, so that volatility is the standard deviation of the continuously compounded
return per year. When volatility is used for risk management, the unit of time is usually one
day so that volatility is the standard deviation of the continuously compounded return per
day.

The volatility can be shown in two ways mainly, Historical volatility and Implied volatility.
Historical volatility (HV) is the volatility experienced by the underlying stock, stated in terms
of annualized standard deviation as a percentage of the stock price. Historical volatility is
helpful in comparing the volatility of one stock with that of another stock or to the stock itself
over a period of time. In contrast to historical volatility, which looks at actual asset prices in
the past, implied volatility (IV) looks ahead. Implied volatility is often interpreted as the
market’s expectation for the future volatility of a stock. Implied volatility can be derived
from the price of an option. Specifically, implied volatility is the expected future volatility of
the stock that is implied by the price of the stock’s options. Although risk managers usually
calculate volatilities from historical data, they also try and keep track of what are known as
implied volatilities. The one parameter in the Black–Scholes–Merton option pricing model
that cannot be observed directly is the volatility of the underlying asset price. The implied
volatility of an option is the volatility that gives the market price of the option when it is
substituted into the pricing model.

There are two types of measuring the volatility models in general. They are Historical
volatility models and conditional volatility models. Various tools have been used to measure
and assess the impact of volatility. The realized volatility computed using mean, variance and
standard deviation represent historical volatility. If one expects the same pattern to follow,
this measure can be extrapolated to future time periods as well. Another method involves
using options as a base for calculating volatility. This alternative is far more intuitive and
forward-looking as the option prices calculated using the Black-Scholes pricing model
indicate the probability of share prices reaching a particular exercise or strike price. This is
because the Black-Scholes model uses five key variables – the current market price of the
underlying asset, the strike price, the risk-free rate of return, time to maturity, and volatility –
This type of volatility measurement captures Implied Volatility, which is a better reflection of
the market sentiment.

1.2 Oil Prices in the World Economy

Since Oil remains as main source of energy for the world. Numerous countries are the
participants in this process. Currently, there are more than 100 oil-exporting countries in the
world. Oil prices affect both oil-exporters and importers. The oil price affects the producers
and the level of production expenditures. Some countries’ economy are highly reliant on oil
and oil products. That is why research on oil and its role in the economy is very important.
Oil factors affect political and economic processes. In turn, these affect the price level,
inflation, economic revival, finance and stock market and economic growth as a whole.
Meanwhile, it affects the formation of alternative energy resources and the development of
these resources.

However, these influences are reciprocal. Thus, some non-oil factors affect oil production
and the development of the oil sector as well as some non-oil factors. The level of oil price
and its formation is determined by the demand and supply of fuel in the world market. It is
divided into traditional and recent factors.

The traditional ones are as follows: a period (of restoration and downsizing) in the world
economy; the magnitude of oil production and extravagant oil deposits; the geopolitical
situation of the main oil exporting regions; information about the exhaustion of oil reserves in
the planet; oil and oil reserves in oil importing countries and the level of reserves of oil
exporting countries; the statements of OPEC members concerning production quotas and
price targets; oil infrastructure and natural and technical calamities; seasonal meteorological
conditions; constraints between supply and demand to oil quality; ecological problems, etc.
The recent ones are as follows: impossibility of regulation of the financial market, opening
oil markets to financing and extreme speculation; the growth of oil demand in new market
economies; the fluctuation of the euro to dollar exchange rate. These and similar factors have
a special weight and influence on the terms of demand and supply in the physical and “paper”
oil markets.

While analysing the oil market structure, it is important to pay attention to standard
parameters of real commodity flow, demand change and the dynamics of oil production in the
main exporting countries. However, oil-importing countries pay attention to the volume of
strategic and commercial reserves. It has a long time that oil prices are not determined as it is
now in the commodity market. Pricing is not carried out in the physical commodity market
but in stock.

As a result of the development of derivative oil trading, a large amount of capital has
penetrated into the market. This tendency has already turned it into a market with a high
volatility from the classic financial market into currency and financial markets. During the
summit in Er-Riad in 2007 November, the heads of state present mentioned that the current
trend in the market that formulates the world oil market is not related to OPEC. The summit
participants concluded that financial factors have a crucial role by analysing the lack of
production capacities in oil production, reduction in the world oil reserves, natural
cataclysms, political events and processes, and financial factors. Oil has turned into a
speculative object in the financial market rather than a real commodity. In this regard, the
role of the oil factor in the economy has been investigated in terms of oil imports, oil
production, economy of exporting countries, conjuncture of financial and stock markets and
exchange rates.

For a long time since the tremendous oil price shocks of the 1970s till the last recent days Oil
prices have been showing spectacular movements which has been at the forefront of the
increase in uncertainty of the energy sector. During the period spanning 2007 to 2008 the oil
price has increased from 60 dollars to cross the threshold of 100 dollars reaching the record
of 147 dollars by barrel in July. The prices have been showing a decrease by August to reach
only 115 dollars, the price that has been dropped back four months later to be traded at 45
dollars at the end of December 2008. The cycle was being launched again around March and
April 2009 when oil was traded at about 40 dollars per barrel to reach by August 2009 the
level of more than 70 dollars per barrel. Actually the Brent oil crude was traded in the first
half of January 2014 at about more than 107 dollars per barrel. The oil price rise and fall
forms one of the serious factors that really affect consumers, producers and Markets
especially in terms of costs, trading strategies and incentives to launch new investment in
technology or reorganize former ones.

After the 1990s, like other former Soviet Union republics, Azerbaijan and Khazakhistan
declared their political independence. They were very strong partners of USSR in the world.
Both of them embarked on producing and exporting hydrocarbon resources to the world
market since they were now politically independent countries. That’s why their social and
economic development, financial stability, GDP and other macroeconomic indicators became
dependent on oil prices. However, these two countries made reforms in order to minimize the
dependency and use resources effectively. Our research and analysis addresses the
significance of this policy.

1.3 BRICs Stock Market and Crude Oil Market

Until now only a short introduction has been given about the impact BRICs will have on the
world's economy and how this might change. In order to support these projections each
country's economy with its strengths and weaknesses has to be stressed out. Also the global
financial crisis has to be included in order to understand each countries growth potential
because global financial instability is still in sight. Furthermore, the focus will be on the
crude oil market as crude oil is a vital source of energy and is likely to remain the same for
many more decades. Thus, of greater interest is the crude oil market within the BRICs and
each country's policy to strengthen its position in market. Moreover, the division of the
BRICS into crude oil exporters and crude oil importers is enthralling when looking at
consequences caused by the crisis.

Brazil's Stock market and Crude Oil Market

The Brazilian stock market has enjoyed years of development, especially during the 1990s
and the late 2000s. The history of the stock market in Brazil dates back to as early as 1817,
when the first Brazilian stock exchange was inaugurated. Today, Brazil has several stock
exchanges, which gradually emerged over the years; and which have also gradually acquired
one another and/or merged over the years to form one big stock exchange: the
BM&FBovespa. The Brazilian stock market is no exception – it lubricates the Brazilian
economy in more ways than one. These include the mobilisation of domestic savings to bring
about the reallocation of financial resources from dormant to active agents, as well as the
enhancement of the inflow of international capital. Despite the importance of the stock
market in the economic growth process of Brazil, this area has not yet been fully explored.
The Brazilian stock market responded largely positively to the various stock market
initiatives implemented over the years. Thus, Brazil achieved substantial progress in stock
market development. The menu of available financial instruments expanded, the market
infrastructure was reformed and strengthened, and a diversified investor base was built.
Despite this notable progress, challenges still remain. These include the still-prevalent short-
term indexation, still low liquidity in the secondary market, and the small number of listings.

Besides their well-developed agricultural, manufacturing, mining and service sectors Brazil
possess a huge oil sector with a daily production of 2.94 million barrels (2020). The long
term goal of the Brazilian government is to increase domestic oil production as domestic
demand is constantly growing and refineries are operating at full capacity. According to BP,
Brazil has 15.3 billion barrels of proven oil reserves and is producing mainly heavy graded
oil. which is sold at a lower price than light graded oil " In 2007 Brazil was announced as
being a net exporter and domestically self-sufficient, although still importing expensive light
crude oil from the Middle East making it more vulnerable to unfavourable crude oil price
fluctuations. However, import of light crude oil is necessary as less costly refining processes
can be achieved for the production of heavy crude oil. A recent discovery of large pre-salt
fields" could break the dependency from the Middle East as it consists of sweet and light
recoverable oil, which is the most valuable quality of oil. Though no confirmation has been
made yet, the estimation for the whole pre-salt field ranges between 30 billion and 100 billion
barrels of oil equivalent. The first company to utilize parts of these pre-salt fields is
Petrobras, one of Brazil's leading oil companies." Nevertheless, the location of the crude oil is
in deep waters and under huge salt layers which gives space for newer technologies and
processes. These new challenges already attracted companies like Siemens, IBM, GE, ABB,
which are building research and development centres in Brazil. Also, Petrobras switched its
internationally oriented strategy to a domestically one and expects to create one thousand
hundred new jobs in order to carry out its huge investment plans.

Russia's Stock market and Crude Oil Market

Moscow Exchange is the largest exchange group in Russia, operates trading markets in
equities, bonds, derivatives, the foreign exchange market, money markets and precious
metals. The Moscow Exchange Group also operates Russia's central securities depository and
the country's largest clearing service provider. The exchange is a result of December 2011
merger of the Moscow Interbank Currency Exchange (MICEX) and the Russian Trading
System. In April 2018, Moscow Exchange signed Memorandum of Understanding (MOU)
with Shanghai Gold Exchange. RTSI is another main index of Russian stock market and
therefore an important indicator of Russian economy. A number of papers have found
influence of oil price volatility on volatility of stock market indicators in oil-exporting
countries, including Russia. But very little was said about such effect since 2014 and
Ukrainian crisis. Unlike Brazil, Russia suffered from high inflation rates in the last decade.
The main reason was a relaxation in monetary and fiscal policy of previous few years, which
furthermore caused a sharp increase in inflation by 14.1% in 2008. As a consequence
economic growth felt dramatically by 7.8%% hitting Russia harder than any other BRIC
country. Several fiscal and monetary policies were suggested to get out of the crisis, like
those from Kudrin (2009) Russian government chose to devaluate its currency, the Rubble, in
favour of the country's competitiveness. Indeed, since the invention of the depreciation policy
annual GDP growth recovered by up to 4.5% and inflation showed significantly lower levels.
In particular, consumption was the main driver for recovery rather than investments as
investors were aware of the heavy crisis impacts. In conclusion, Russian's economy is less
diversified than its BRIC counterparts and is highly dependent on natural resources like oil.
Being the second largest oil producer with a daily production of 10.26 million barrels (2020)
and a major exporter with exports of 3 million oil barrels per day, Russia's economy is mainly
oil driven and depends on oil exports. Around 75% of all oil exports go to European countries
like Germany. Netherlands and Poland and the 16% go to Asia and the remaining 6% to
North and South America. According to BP's "Statistical Review of World Energy June 2013
Russia has proven reserves of 87 billion barrels. However, the oil market in Russia is less
dominated by international firms instead Russian ones like Rosneft, Lukoil, TNK-BP.
Surgutneftegaz and several other smaller ones run the industry. The biggest threat for the
country and its exports is the forecasted decline in oil output due to maturity of conventional
resources" Thus. Rosneft started exploiting unconventional resources, which are more
difficult to extract and need different technology than conventional resources. Through the
newly built Eastern-Siberian-Pacific Ocean pipeline an average of 300,000 bbl/day is now
being pumped into Asia. Supply can be increased between 600.000 and I million bbl/day as
soon as the last channels of the expenditure process finish. A full report on strategic
movements for the complete energy sector until 2030 was published by the Ministry of
Energy. This offers prospects, trends and an implementation system for the strategy.
Obviously, Brazil and Russia have in common their huge oil reserves and are more or less net
exporters of oil. In contrast to these two open economies, India and China are more closed
economics with vast demand in oil and thus making them net importers.

India’s Stock market and Crude Oil Market

Most of the trading in the Indian stock market takes place on its two stock exchanges: the
Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE). The BSE has been
in existence since 1875. The NSE, on the other hand, was founded in 1992 and started trading
in 1994. However, both exchanges follow the same trading mechanism, trading hours, and
settlement process. Almost all the significant firms of India are listed on both the exchanges.
The BSE is the older stock market but the NSE is the largest stock market, in terms of
volume. As such, the NSE is a more liquid market. In terms of market cap, they're both
comparable at about $2.3 trillion. Both exchanges compete for the order flow that leads to
reduced costs, market efficiency, and innovation. The presence of arbitrageurs keeps the
prices on the two stock exchanges within a very tight range. The Indian retail investors
generally believe that the Indian stock markets follow unpredictable patterns governed
primarily by investor psychology and market manipulations and are therefore unpredictable.
Slightly more than half of the Indian work force belongs in agriculture, but the 57% main
driver of the economy's growth lies in the service sector. This accounts for 57% of India's
output. India's economy showed resilience during financial crisis with an average growth rate
of 3.9% and its pace of recovery has been remarkable with sharp rises in GDP of 8.5% and
10.5% during early 2000s. Nonetheless, printing more money during 2008 and 2009 to
stimulate the economy caused a rise in inflation. Several attempts to reduce inflation failed
leading to a constantly depreciation of the currency. Since 2012 slow entrance of economic
reforms have been affecting investor's behaviour leading to a decline in investments. As a
result, India's economy only grew an average of 3.2% but now India's real GDP (Gross
Domestic Product)is estimated to contract by 7.7% in 2020-21.

After the US. China and Japan, India is the fourth largest energy consumer and importer of
oil. The low per capita energy consumption of 107kg per capita of all equivalent in 2020 is
attributed to the industrial sector. India is now at the beginning of the industrialization
process. With a demand of 40% on total primary energy demand the industrial sector is the
largest energy consumer in India, In total, India consumed 4.9 million bbl/d in 2020 for crude
oil. The consumption has been growing annually by 4. Its 5.7 billion barrels of reserves are
not sufficient enough to meet these needs and thus imports. which cover 75 of consumption,
will further rise. Currently 64% of all crude oil is imported from the Middle East (Saudi
Arabia. Iraq. Kuwait, United Arabic Emirates and Iran, 7 from Africa and 19% from several
other countries. As a protection pillar to supply disruptions from the Middle East due to their
high political instability and unfavourable oil price changes India set up in 2005 a strategic
storage plan. This enables the country to store 37 million barrels of crude oil. In 2020 this
number is reached to 132 million barrel. Another challenge for the India oil market is
constant oil production. Not all reserves have been exploited because they require greater
technical expertise. International oil companies could provide the necessary technology to
raise domestic oil production and make it more efficient but complex laws and policies
distract this opportunity. Nevertheless, two state owned companies, the Oil and National Gas
Corporation (ONGC), which is responsible for 771 of crude oil production, and Oil India
Limited, which owns the majority of the refineries, control the oil market. Similar patterns in
the oil market can be seen in China, which is undoubtedly the biggest economy in terms of
GDP among the BRIC. Unlike India, China has consistent policies to deal with issues of its
economy.

China’s Stock market and Crude Oil Market

China’s stock market was established in the early 1990s. When China first began
privatization of its state-owned enterprises in 1990s, it wanted to use capital market pressures
to improve the performance of state-owned enterprise. To allow companies to raise capital, a
two-tier ownership structure was put in place and until 2001, domestic investors could only
buy A shares while foreign investors could hold B shares. Despite the capital market
segmentation, the stock market has developed quickly and is becoming an indispensable part
of China’s financial infrastructure. There are two exchanges on the mainland. The Shanghai
and Shenzhen exchanges were opened by the Chinese government in 1990 as a way of
modernizing China's economy. The Shanghai stock exchange is China's largest. Most of the
companies listed are the large, state-owned companies responsible for China's economic
growth. The Shenzhen stock exchange is a smaller exchange. The Shenzhen trades the shares
of smaller, more entrepreneurial companies.
China is an even bigger consumer and importer of crude oil than India consuming 13.51
million bbl/day. Between 2002 and 2012 oil consumption growth had doubled and in 2012
China contributed to half of world's oil growth. Facing similar issues like India, China's
production has peaked as oil fields are becoming mature, Currently China is producing 3.87
million barrels per day. China's crude imports from the US surged 211% year on year to
19.76 million mt, or an average 395,746 b/d, in 2020, with the value jumping 89% to $6.28
billion. Since the last oil price crash in 2014, China has been accelerating its crude imports
for strategic and commercial storage from about 200 million barrels in 2014 to 900 million
barrels in 2019. This is equivalent to about 70 days of its 2019 oil demand and 70% of its
2019 total storage capacity. China is expected to continue importing crude to fill its reserves
taking advantage of lower oil prices. But this time, China could build its crude reserves by up
to 300,000 barrels per day (b/d) from March 2020 to the end of 2020, due to limitations in
storage capacity, as storage capacity utilisation reaches 90% this year. This fill rate is also
less than half of what we have seen in the last two years, hence providing less support to oil
prices than usual this time. In order to protect its economy China is diversifying oil supplies
through overseas investments and long-term contracts, such as the one contracted with
Russia. China has tight controls over the oil markets and especially on crude oil imports.
Thus, the oil market is mostly influenced by the China National Petroleum Corporation
(CNPC) including its arms PetroChina and China Petroleum & Chemical Corporation
(Sinopec). CNPC contributes with 60% of oil output and is the leading exploration and
production company. Sinopec on the other hand is specialized on refining and distribution,
which makes 80% of its revenues. Both companies put effort on increasing the recovery ratio
in matured oilfields and exploitation of offshore areas. Lately, these fields were discussed to
open for international oil companies in order to push competition between the two state
owned companies and to keep oil supply generous although the fields have become matured.
It is clear that all four countries of BRICs nations put much effort to stabilize their economy
and protect their oil market from unfavourable changes.

1.4 Introduction of Brent oil prices

Brent Crude is a major trading classification of sweet light crude oil that serves as a major
benchmark price for purchases of oil worldwide. This grade is described as light because of
its relatively low density, and sweet because of its low sulfur content. Brent Crude is
extracted from the North Sea in 1976. The other well-known classifications (also called
references or benchmarks) are the OPEC Reference Basket, Dubai Crude, Oman Crude, Urals
oil and West Texas Intermediate (WTI). It is referred to any or all of the components of the
Brent Complex, a physically and financially traded oil market based around the North Sea of
Northwest Europe; colloquially, Brent Crude usually refers to the price of the ICE Brent
Crude Oil futures contract or the contract itself.. As production from the Brent oilfield
declined over time, crude oil blends from other oil fields have been added to the trade
classification. The current Brent blend consists of crude oil produced from the Brent, Forties
(added 2002), Oseberg (added 2002), Ekofisk (added 2007), and Troll (added 2018) oil fields
(also known as the BFOET Quotation). The Brent Crude oil marker is also known as Brent
Blend, London Brent and Brent petroleum. This grade is described as light because of its
relatively low density, and sweet because of its low sulphur content.

Brent is the leading global price benchmark for Atlantic basin crude oils. It is used to set the
price of two-thirds of the world's internationally traded crude oil supplies. It is one of the two
main benchmark prices for purchases of oil worldwide, the other being West Texas
Intermediate (WTI). According to a January 2020 EIA report, the average price of Brent
crude oil in 2019 was $64 per barrel compared to $71 per barrel in 2018. The average 2021
annual price of Brent crude oil climbed to 58.53 U.S. dollars per barrel, as of February. This
is nearly 17 U.S. dollars higher than the annual average in 2020, when weakened demand
during the coronavirus pandemic resulted in an oil crisis. Brent is the world's leading price
benchmark for Atlantic basin crude oils. Crude oil is one of the most closely observed
commodity prices as it influences costs across all stages of the production process and
consequently alters the price of consumer goods as well. In the past decade, crude oil prices
have been especially volatile. Their inherent inelasticity regarding short-term changes in
demand and supply mean that oil prices are erratic by nature. However, the changes in
demand and supply due to the economic growth by BRIC countries such as China and India
and the advent of hydraulic fracturing and horizontal drilling in the U.S. have greatly
contributed to the price volatility observed since the 2009 financial crisis. It is considered a
sweet light crude oil due to its low sulfur content and a low density and may be easily refined
into gasoline. Often, this crude oil is refined in Northwest Europe.

1.5 The Relationship between Stock market volatility and Oil prices
The dynamic relation between global crude oil prices and stock prices is investigated in terms
of crude oil-exporting and -importing countries. The relationship between crude oil prices
and stock prices is examined for BRICS countries (Brazil, Russia, India, China, and South
Africa) for the periods of January 2011 to December 2020.