Energy Economics 51 (2015) 590–598

Contents lists available at ScienceDirect

Energy Economics

journal homepage: www.elsevier.com/locate/eneco

Oil volatility shocks and the stock markets of oil-importing MENA

economies: A tale from the financial crisis
Elie Bouri ⁎
USEK Business School, Holy Spirit University of Kaslik, POBOX 446 Jounieh, Lebanon

a r t i c l e i n f o a b s t r a c t

Article history: The role of oil price volatility in predicting the stock-market volatility of small oil-importing countries that have a
Received 24 February 2015 substantial number of investors from neighboring oil-exporting countries remains unexplored. To refine our
Received in revised form 30 June 2015 basic understanding of this role, this paper proposes a methodological extension of the recently developed
Accepted 1 September 2015
causality-in-variance procedure and considers the case of Lebanon and Jordan. These two heavy importers of
Available online 14 September 2015
oil are interesting in the sense that they are located in a region with a large number of rich oil-exporting coun-
JEL classification:
tries, so their stock markets are tied to oil-exporters by way of foreign investors. The conditional mean and
C10 variance of returns are modeled within an ARMAX–GARCH framework that accommodates three salient features
C32 of the data, namely: autocorrelation, day-of-the-week effects, and movements in international markets. For com-
C58 parison purposes, the stock markets of Morocco and Tunisia are also included in the study. Empirical analyses
G10 highlight the dynamic effects of the global financial crisis on the volatility spillovers between oil and the stock
G12 markets of oil-importing countries and provide more insights into the seemingly contradictory effects of being
Q43 oil-importers while having investors from oil-exporting countries. The main results indicate that the volatility
spillover is much more apparent from the world oil market to the stock market of Jordan than the other way
Keywords:
Volatility spillover
around, whereas oil volatility is not a good predictor of Lebanese stock market volatility. Finally, policy/practical
Crude oil implications and conclusions for future research are drawn.
Stock market © 2015 Elsevier B.V. All rights reserved.
MENA net oil importers
ARMAX
GARCH

1. Introduction There is a considerable body of literature on oil and stock markets in

The importance of oil to the economic and political development of
industrialized and developing countries cannot be overstated. However,
sharp fluctuations in oil prices can more strongly affect the future eco-
nomic growth and stability of developing countries, given that these
countries experience more-rapid economic growth and are more ener-
gy intensive (Bhar and Nikolova, 2009).
In addition to their effects on the economy, changes in the price of oil
and its volatility have been recently examined in relation to stock mar-
ket returns. Under the assumption that economic agents are rational, it
is very convenient that portfolio managers optimize the combination of
oil and stocks in the portfolio to minimize risk, rather than investing in
only one of the two. For policymakers, the formulation of appropriate
plans of action to effectively cushion any potential impacts of oil volatil-
ity shocks and to avoid financial contagion, particularly during crisis
periods, depends on how volatility transmissions are structurally
modeled.
⁎ Tel.: +961 9 600 800; fax: +961 9 600 801.
E-mail address: eliebouri@usek.edu.lb.
the context of large oil-importing economies such as the US, Europe, and
China (Arouri et al., 2012; Cuando and de Garcia, 2014; Broadstock and
Filis, 2014) and oil-exporting economies such as Gulf Cooperation Coun-
cil (GCC) countries (Mohanty et al., 2011; Jouini and Harrathi, 2014; Ma
et al., 2014). In general, this literature indicates that the stock markets of
net oil-importing countries can be depressed from rising oil prices,
whereas the stock markets of net oil-exporting countries can benefit
from higher revenues and wealth.
Regarding the context of small oil-importing countries in the Middle
East and North Africa (MENA), the oil–stock nexus remains largely
understudied. Against this background, this paper is a further step in
understanding the causal relationship in variance between the world
oil market and the stock markets of two heavily oil-importing MENA
countries, namely Lebanon and Jordan. At first glance, this literature
gap seems to be somewhat small if we consider the ample evidence
on the existence of the negative impacts of oil price changes on stock
market activities in (large) oil-importing countries outside the MENA
region. However, the nature and direction of volatility spillovers
between the world oil market and the stock markets of Lebanon and
Jordan may be complex and thus different. Lebanon and Jordan are illus-
trative cases not just because their economies are heavily oil importing

http://dx.doi.org/10.1016/j.eneco.2015.09.002
0140-9883/© 2015 Elsevier B.V. All rights reserved.
 E. Bouri / Energy Economics 51 (2015) 590–598
but also because they are surrounded by rich GCC oil-exporting coun-
tries, so their stock markets are tied to these oil exporters by way of
foreign investors. While the direct effects of rising world oil prices are
expected to be negative for net importers and extremely energy-
intensive economies such as Lebanon and Jordan1, the indirect (hidden)
effects on stock market activities are, however, expected to be positive.
Given that a substantial number of investors in the Lebanese and
Jordanian stock markets are from neighboring GCC oil exporters, the
resulting increase in oil export revenues can be used as an argument
for more investment in these two stock markets. Also, rising oil
prices may boost the level of non-resident deposits in Lebanese
and Jordanian banks, suggesting a positive impact on the profitabil-
ity of banks and relatively more-significant effects on overall stock
market returns if we consider the large size of the banking industry
in these two countries.
In this context, exploring the extent to which oil price volatility
shocks are transmitted to the stock markets of Lebanon and Jordan
and vice versa enriches the basic understanding of volatility spill-
overs between oil prices and stock markets in oil-importing coun-
tries and provides valuable insights regarding information flows
across markets.
To proceed with the empirical analysis on the risk spillovers be-
tween oil and stock markets, we employed the Lagrange multiplier
(LM) test for causality in variance developed by Hafner and Herwartz
(2006) and recently used by Nazlioglu et al. (2013) in the commodity
markets. In general, causality in variance has received insufficient atten-
tion in the prior literature on the oil–stock nexus. Although we adopted
the causality-in-variance test outlined in Hafner and Herwartz (2006),
we departed from it and broadened its framework in several impor-
tant ways. First, we used a flexible model description using a general
autoregressive-moving-average model with external input (ARMAX)
and a conditional variance based on a GARCH process. The conditional
mean was specially tailored to the dataset to take into account the effect
of worldwide price movements, any predictability associated with lagged
returns, and non-synchronous trading, whereas the conditional variance
was specified to account easily for conditional heteroskedasticity in
returns and asymmetric responses to positive and negative shocks
(Chau et al., 2014). This tailoring was important because the stock mar-
kets of Lebanon and Jordan are generally less developed and less efficient
than other emerging markets, and their returns may thus be influenced
by the past values of several endogenous and exogenous factors. Second,
extensive specification tests for the most appropriate univariate GARCH
process along with its corresponding error distribution were conducted
because the return series generally showed evidence of deviations from
normality, volatility clustering, and fat tails. For each of the return series,
the best univariate symmetric or asymmetric ARMAX–GARCH model
specifications were selected following the procedure of Beine and
Laurent (2003). Compared to the methodology applied by Nazlioglu
et al. (2013) in the oil–agricultural commodity nexus, our richer and
more flexible methodology allowed us to better capture many of the sa-
lient features of the data by estimating the best fitting univariate model,
instead of an ad-hoc selection. Put differently, our methodology enabled
us to improve the assessment of cross-market volatility spillovers and
thus to avoid probable spurious results of the causality-in-variance test
due to unobserved features of the data or GARCH specification bias.
Otherwise, misspecifications in the GARCH-based process can give rise
to the incorrect assessment of risk and, eventually, to invalid input into
the decision-making process. Given that risk spillover represents the
dependence of a given asset variance on the past variance of any other
asset, biased estimates of volatility spillovers between assets lead to
incorrect assessments of portfolio risk and to the ill-effects of portfolio
optimization, both of which will decrease portfolio efficiency.
1
In 2013, energy imports in Lebanon and Jordan accounted respectively for 90% and
88% of total primary energy demand.
591
Our empirical model was applied to a dataset that includes daily
observations from 3 April 2003 to 11 December 2013 and accounted
for the impact of the global financial crisis of 2008 on our analysis. The
sample choice allowed us to conduct a comparative study of volatility
spillovers between oil and stock markets in the pre- and post-crisis
periods.
Our main contributions were threefold. First, we focused for the first
time on volatility spillovers within the oil–stock nexus using the
causality-in-variance test proposed by Hafner and Herwartz (2006).
Second, we concentrated on the stock markets of heavily oil-importing
MENA economies, in our case Lebanon and Jordan. These two markets
had not been previously analysed in the literature on the oil–stock risk
nexus, even though they are surrounded by rich oil exporters, so the
extent to which oil price volatility shocks are transmitted to the stock
markets of Lebanon and Jordan and vice versa may be different from
other markets. Finally, unlike prior studies, we accounted for thin
trading and movements in international stock markets in order to
more accurately capture the volatility spillover effects between oil and
stock markets.
Our empirical analysis provided a number of interesting findings.
Firstly, the riskiness of the Jordanian stock market was not responsive
to that of the world oil market until August 2008, suggesting that the
pricing of stock index futures and options is subject to oil price volatility
in the aftermath of the global financial crisis. Secondly, in the post-crisis
period, the volatility spillover from the world oil market to the
Jordanian stock market was significant, whereas the feedback effect
was much weaker. Thirdly, there was no significant evidence to show
that the Lebanese stock market was influenced by the riskiness of the
world oil market, suggesting that oil volatility makes no contribution
to forecasts of future price volatility in the Lebanese stock market.
Finally, by considering the cases of Tunisia and Morocco, we found
that the presence of foreign investors from oil exporters can engender
higher inconsistency in how the stock markets of small oil-importing
MENA countries – in our case Lebanon and Jordan – respond to oil
volatility shocks.
The following sections of the paper present the interaction between
the world oil market and the stock markets of Lebanon and Jordan, the
literature review, the data and methodology, the empirical results, and
the conclusions.
2. The impact of world oil prices on stock market returns in Lebanon
and Jordan
2.1. Oil prices and stock market activities in Lebanon and Jordan
Located in a region with a large number of oil-exporting countries,
the stock markets of Lebanon and Jordan represent an attractive re-
search field because of the potentially complex relationship between
oil risk shocks and stock market activities. On the one hand, the depen-
dence of the Lebanese and Jordanian economies on foreign oil imports
renders these economies and their stock market returns more vulnera-
ble to the ongoing instability and risk in the world oil market. An oil
price increase often leads to a higher cost of production, as crude oil is
one of the most important production factors. This in turn leads to
higher consumer prices, lower aggregate demand, and thus lower con-
sumer spending (Arouri and Rault, 2010). Higher production costs gen-
erally lead to lower profitability, whereas lower consumption hinders
production, leading to lower corporate sales and profits. All these ad-
verse factors may trim down dividends and thus stock prices. On the
other hand, the particularity of the Lebanese and Jordanian stock mar-
kets in terms of their reliance on foreign investors from neighboring
oil-exporting GCC countries suggests that rising oil prices could indi-
rectly boost foreign investment and thus the demand for local stocks
(Bouri, 2015). Rising oil prices encourage both higher regional demands
for the highly esteemed Lebanese and Jordanian properties and a boost
to the level of non-resident deposits in local banks. These in turn could
592 E. Bouri / Energy Economics 51 (2015) 590–598
enhance corporate profits and thus stock prices. In particular, the large
sizes of the financial and real estate sectors relative to the total market
capitalization in both Lebanon and Jordan suggest a more significant
effect of rising oil prices on stock market returns.
Conversely, two features of the Lebanese and Jordanian stock mar-
kets imply that both the negative and positive effects of oil price chang-
es on business investments and corporate profits may not be easily
transmitted to stock prices as in the cases of larger oil-importing and
oil-exporting countries. First, the lack of liquidity in the local stock mar-
kets represents a hurdle to risk spillovers from oil to stocks. Second, the
Lebanese stock market and to a lesser extent the Jordanian stock market
largely consist of banking and services companies, which are weakly
dependent on oil risk shocks. In Lebanon (Jordan), almost 77% (62%)
of the market capitalization of companies belongs to the financial sector,
suggesting a very weak influence of the risk of the oil market on that of
stocks.
Potentially, all these factors will make the analysis for risk spillovers
between the world oil market and the stock markets of Lebanon and
Jordan more interesting for the local and global business community.
2.2. Characteristics of the stock markets of Lebanon and Jordan
The stock markets of Lebanon and Jordan, which are fully accessible
to foreign investors, suffer from the ongoing regulatory supervision of
exchanges and trading systems. Local banks continue to dominate fi-
nancing, as shallow and underdeveloped capital markets do not provide
the best setting for local firms to access capital easily. Several reforms
have been adopted in this regard to enhance transparency and to
open up markets. The establishment of capital market authorities in
Lebanon represents the most recent effort by the Lebanese government
to encourage the capital markets and boost market transparency.
Due to their different inception dates, the stock markets in the two
countries differ (see Table 1). Jordan is one of the most diversified
stock markets in the MENA region (Bouri and Yahchouchi, 2014). It
has 277 listed companies belonging to three main sectors, namely: fi-
nancial, services, and industries, and their subsequent 20 sub-sectors.
Recognized by the groups of Morgan Stanley Capital International
(MSCI) and Standard and Poor as a frontier market2, Jordan is also on
the watch list for potential future reclassification as an emerging mar-
ket. In Lebanon, the stock market is much smaller, less liquid, and far
more concentrated than that in Jordan. It only has ten listed companies
classified into four sectors: banking, development and reconstruction,
trading, and industrial. In both countries, however, the stock market
capitalization does not exceed GDP, even though the Jordanian market
is substantially larger. Compared to other MENA markets, Lebanon has
both the second smallest and the second least liquid exchange after
Tunisia and Bahrain, respectively (Bouri, 2014). By contrast, Jordan
is relatively better positioned in terms of market capitalization and li-
quidity. Regarding the ratio of net foreign assets to economic output,
Lebanon has a better status.
3. Related work
In addition to investigating the relationship between crude oil prices
and macroeconomic activities, a number of recent papers have ad-
dressed the links between oil and stock markets. Many of these pa-
pers have considered the cases of developed countries. Vo (2011)
used a GARCH-based framework and found that there is intermarket
dependence in volatility between the global oil market and the US
stock market. Qinbin and Mohammad (2012) used regression analyses
to examine in what way the reactions of stock returns to oil price fluc-
tuations differed across 49 US industries for the period 1979–2009.
2
Markets are classified and segregated into developed, emerging, and frontier markets.
Table 1
Stock markets in Lebanon and Jordan.
Lebanon Jordan
Year of establishment 1920 1999
Number of listed firms 10 277
Market capitalization (US$ bn) 10.29 26.99
Market capitalization/GDP 27.11 94.30
Turnover ratio % 4.09 10.30
Net foreign assets/GDP 0.903 0.282
Oil imports/GDP 0.108 0.117
Accessibility Fully accessible Fully accessible
Notes: All figures are for 2013. Listed stocks are the number of domestic listed companies.
Turnover ratio corresponds to the total value of shares traded during the period divided by
the average market capitalization for the period. Source: Reuters DataStream.
Arouri et al. (2012) used bivariate models for weekly data from the US
and Europe and found substantial volatility spillovers between oil prices
and stock indices. Chang et al. (2013) report similar results in their
study of US and UK stock prices. Cuando and de Garcia (2014) used vec-
tor autoregressive (VAR) and vector error correction (VEC) models for
the period from February 1973 to December 2011 and report a negative
and significant impact of oil price changes on most European stock mar-
ket returns. Broadstock and Filis (2014) applied a multivariate model
and unconditional correlation analyses to US stock market data for the
period 1995–2013 and underline the effect of oil price shocks on aggre-
gate and sectorial stock returns. Kang et al. (2015) assessed the impact
of oil price shocks on the US stock market return and volatility using a
structural VAR model and variance decompositions on daily data from
1973 to 2013. Khalfaoui et al. (2015) used a wavelet-based GARCH ap-
proach and examined the linkage of the crude oil market (WTI) and the
stock markets of G7 countries. They found evidence of significant vola-
tility spillovers between oil and stock markets.
Recent papers studying the effects of oil prices on stock market
returns have also considered the cases of developing countries. These
include, among others, Cong et al. (2008) for China, Narayan and
Narayan (2010) for Vietnam, Masih et al. (2011) for South Korea,
Nguyen and Bhatti (2012) for Vietnam and China, Ghosh and Kanjilal
(in press) for India, and Zhu et al. (2014) for ten Asian-Pacific countries.
Many other studies have also considered the cases of GCC oil-exporting
countries and have suggested that there is weak consensus on the posi-
tive impact of oil price fluctuations on stock market activities. Lescaroux
and Mignon (2008) focused on the long-term and short-term relation-
ships between oil prices and stock prices, reporting a positive causality
running from oil prices to stock prices in Qatar, Saudi Arabia, and the
United Arab Emirates. Mohanty et al. (2011) used factor analysis and
found a positive relationship between oil prices and stock returns in
GCC countries, except for Kuwait. Fayyad and Daly (2011) applied a
VAR analysis and emphasized the predictive power of oil prices for
stock returns in GCC countries, the UK, and the US, in particular during
the global financial crisis. Arouri et al. (2011) and Jouini and Harrathi
(2014) found a stable long-term relationship between oil prices and
GCC stock prices, as well as substantial return and volatility linkages.
Awartani and Maghyereh (2013) reported a two-way feedback relation-
ship between the volatility of crude oil and GCC stock returns, in partic-
ular in the aftermath of the global financial crisis. Ma et al. (2014)
observed meaningful cross-correlations between oil prices and the
GCC stock markets.
As previously indicated, the risk of spillovers between the world oil
market and the stock markets of heavily oil-importing countries has re-
ceived much less attention in the MENA region. The one study to date
that has examined the issue of volatility spillovers in oil-importing
MENA countries was conducted by Bouri (2015) on Lebanese stocks.
The author applied a bivariate VAR–GARCH model and found weak
unidirectional return and volatility transmissions from oil prices to the
Lebanese stock market. With a different methodology based on the
LM test for causality in variance within an ARMAX representation of
 E. Bouri / Energy Economics 51 (2015) 590–598 593

GARCH models, this research concentrates on the stock markets of two capable of modeling the conditional time-dependent second moment
heavily oil-importing countries located in a region characterized by the of the return distribution. In addition, Table 2 highlights the weak de-
presence of rich oil exporters. gree of correlation between the variables in both periods, implying the
diversification advantages of the inclusion of oil assets in equity
4. Data and empirical model portfolios.

4.1. Data and summary statistics 4.2. Empirical model

The empirical period started on 3 April 2003 and ended on 11
December 2013. The entire sample period was divided into two pe-
riods of equal length: pre-crisis (3 April 2003–30 July 2008) and
post-crisis (1 August 2008–11 December 2013), so the empirical
analyses could easily take into account the possible effects of the
global financial crisis. This study used daily data on Brent spot oil
prices and stock indices from two oil-importing MENA countries
(Lebanon and Jordan) for a total of 2526 common observations.
Brent oil prices were obtained from the Energy Information Admin-
istration, whereas stock price indices were obtained from the MSCI
Barra database. The MSCI World Index was also used as a proxy for
the international stock market in order to account for the world in-
fluence. The logarithmic price returns of all variables were used in
the empirical analyses.
Before proceeding to the econometric methodology and analysis, the
summary statistics of oil prices and stock indices are reported in Table 2.
Based on the skewness and kurtosis values, all return series showed
significant deviations from normality over both periods. Overall, the ex-
cess kurtosis and skewness were more pronounced after the crisis than
before. The results of the Portmanteau test confirmed the presence of
serial correlation in the return series in most cases. For all series, the
Engle ARCH statistic rejected the null hypothesis of no conditional
heteroskedasticity at the 1% level. Based on the above characteristics
of the data, it was appropriate to use a GARCH-type model, which is
The empirical framework adopted followed the two-step methodol-
ogy proposed by Hafner and Herwartz (2006) and recently employed in
the oil–agricultural commodity nexus by Nazlioglu et al. (2013). Hafner
and Herwartz (2006) indicate that their test is based on the principle of
LM so that it can overcome the shortfalls encountered in the tests devel-
oped by Cheung and Ng (1996) and Hong (2001), which are based on
the principle of cross-correlation function (CCF). As shown by Hafner
and Herwartz (2006:140), the CCF-based test displays “significant
oversizing in small and medium samples when the volatility process
is leptokurtic” and is highly sensitive to the order of leads and lags.
For that reason, Hafner and Herwartz (2006) used a Monte Carlo simu-
lation to underline the robustness of their LM-based approach when
leptokurtic innovations in small samples are considered.
The first step of the LM test for causality in variance involved the
estimation of univariate GARCH-based models to account for the time
variance in both conditional means and conditional variances. In this
study, this step was broadened to address most of the features in the
Lebanese and Jordanian stock indices, including market anomalies
such as potential autocorrelation, day-of-the-week effects, and world-
wide price movements (Chau et al., 2014). This methodological broad-
ening of the first step was important in the sense of avoiding biased
estimates of risk spillovers caused by a shift of focus from the unpredict-
able component of returns. The result is an autoregressive-moving-
average with an external input (ARMAX) process for the conditional
mean. The ARMAX(p,q) model can be written as:

Table 2 Rt ¼ a0 þ a1 Rt−p þ a2 εt−q þ a3 Rw;t−1 þ a4 Dayt þ a5 Othert−1 þ εt ð1Þ

Summary statistics.

3 April 2003–30 July 2008 1 August 2008–11 December 2013

where Rt is the daily return on each price series on day t; Rw,t is the daily
Oil return on the world market index on day t; Rt − p is the lagged daily re-
Mean 0.0012 −0.0000 turn on each price series; and Dayt is a 4 × 1 vector of dummy variables
SD 0.0206 0.0227
Skewness 0.0394 0.3569
such that the first element is 1 if Dayt is Monday and 0 if otherwise. εt − q
Kurtosis 4.1778 10.5030 is the lagged residuals, and Othert is a 3 × 1 vector of the daily return on
Q (5) 3.1901 10.7089⁎ the other market price series; however, we restricted the coefficients of
Q (10) 7.4308 17.0790⁎ Othert to 0 in the oil equation.
ARCH(10) 30.1185⁎⁎⁎ 117.5085⁎⁎⁎
Regarding the conditional variance process, extensive specification
Lebanon tests for the most appropriate GARCH-based process along with its cor-
Mean 0.0012 −0.0004 responding error distribution were conducted along the lines of Beine
SD 0.0143 0.0080
and Laurent (2003), instead of an ad-hoc selection. Specification tests
Skewness −0.2117 −0.0084
Kurtosis 14.2904 17.0065 were important because the return series generally showed evidence
Q (5) 47.9180⁎⁎⁎ 46.9230⁎⁎⁎ of deviations from normality, volatility clustering, and fat tails. Mis-
Q (10) 50.7390⁎⁎⁎ 59.3760⁎⁎⁎ specification in fitting a GARCH-type model together with an imprecise
ARCH(10) 139.603⁎⁎⁎ 196.7143⁎⁎⁎ assumption of the error-term distribution may substantially undermine
Jordan the efficiency of the related estimators. More specifically, we applied
Mean 0.0010 −0.0008 two univariate models for the conditional variance: a standard GARCH
SD 0.0135 0.0127 model (Bollerslev, 1986) and an asymmetric GARCH model in line
Skewness −0.4740 −0.6223
Kurtosis 9.4968 12.2793
with Glosten et al. (1993), known as a GJR–GARCH model. The standard
Q (5) 1.9938 27.0470⁎⁎⁎ GARCH at time t has the form:
Q (10) 6.5571 33.9310⁎⁎⁎
ARCH(10) 73.7534⁎⁎⁎ 188.5402⁎⁎⁎
σ t2 ¼ ω þ α εt−1
2 2
þ β σ t−1 ð2Þ
ρ (oil-Lebanon) −0.0304 0.0825
ρ (oil-Jordan) 0.0021 0.0342
Obs 1263 1263
The ARCH term α measures the impact of past innovations on cur-
Notes: This table reports the descriptive statistics of the return series; SD (standard devia- rent variance, whereas the GARCH term β measures the impact of past
tion); Q (Ljung–Box statistics for serial correlation in the returns); ARCH (statistics for Engle's variance on current variance. Further, the sum of the ARCH and
heteroskedasticity test); ρ (unconditional correlation coefficient); and Obs (number of
observations).
GARCH parameters (α + β) is used to measure the degree of persistence
⁎⁎⁎ Indicates statistical significance at the 1% level for the Q and ARCH tests. of the variance shocks. For stationarity and stability, the GARCH model
⁎ Indicates statistical significance at the 10% level for the Q and ARCH tests. has the following constraints: ω N 0; α ≥ 0; β ≥ 0; α + β b 1.
594
To capture any potential asymmetry in the return series, the follow-
ing GJR–GARCH model relaxes the assumption of symmetry in the
conditional volatility specification:
σ t2 ¼ ω þ α ε2t−1 þ β σ t−1
2 2
þ dεt−1 Iεb0 ðε t−1 Þ
where σt2 is the conditional variance at time t, εt − 1 is the innovation at
time t − 1 and I is a dummy variable that measures the asymmetric re-
sponse of the conditional variance to unexpected price decreases. I takes
a value of 1 in response to negative shocks and 0 in response to positive
shocks. A positive and significant value of γ indicates that a negative
shock increases future conditional variance more than a positive shock
of the same magnitude. For stationarity and stability, the following con-
straints must be respected: ω N 0; α ≥ 0; β ≥ 0; β + d ≥ 0; α + β + 0.5
d b 1.
Using the maximum likelihood approach, the conditional volatility
was estimated using the three probability distributions: the normal,
the t-distribution, and the generalized error distribution (GED). Follow-
ing Hansen and Lunde (2005), the conditional variances were based on
a GARCH (1,1) specification, which performs well in most situations
compared to other GARCH lag specifications. Along the lines of Beine
and Laurent (2003), the order of the ARMA specification as well as the
type of GARCH formulation and its related density were selected by re-
lying on Schwarz's Bayesian information criterion (SIC), which is known
for leading to a parsimonious specification. We also employed several
diagnostic tests for the residuals and the squared residuals for each se-
lected model to ensure that the conditional variance process fitted
well with the return series.
After fitting the return series to the most appropriate ARMAX–
GARCH/ARMAX–GJR–GARCH process, the next step consisted of testing
the following null hypothesis of no causality in variance between series i
(oil index) and series j (stock index):


ð jÞ
H0 : Var εit jF t−1 ¼ Varðε it jF t−1 Þ
ð jÞ
where F t = F t \σ (εjτ, τ ≤ t) and εit are the residuals from the GARCH-
based model for the series i. The null hypothesis was tested by consider-
ing the model:
qffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi
 

ε it ¼ ξit σ 2it 1 þ z jt ′π ; z jt ¼ ε 2jt−1 ; σ 2jt−1 0
where σit2 and ξit represent respectively the conditional variance and the
standardized residuals for the series i. σjt2 − 1 and εjt2 − 1 represent respec-
tively the conditional variance and the squared standardized residuals
for the series j. In Eq. (5), a sufficient condition for Eq. (4) is π = 0, so
the null hypothesis of the no-causality-in-variance LM test H0: π = 0
was tested against the alternative hypothesis of the LM test H1: π ≠ 0.
An LM statistic can be constructed by means of estimated univariate
GARCH processes. The score of the Gaussian log-likelihood function of
εit is given by xit(ξ2it − 1)/2, where the derivatives xit ¼ σ it −2 ð∂σ it 2 =∂θi Þ,
θi = (ωi, αi, βi)′.
The following test statistic was then used to examine the volatility
spillovers between the two series:
! !
T

X  T

X 
1 d
ξit −1 z jt ′ V ðθi Þ−1
2 2
λLM ¼ ξit −1 z jt → Chi‐square ð6Þ
4T t¼1 t¼1
!−1
T T T T
where Vðθi Þ ¼ 4Tκ ∑z jt z jt ′−∑z jt xit ′ ∑xit xit ′ ∑xit z jt ′ ; κ ¼ T1 ∑ ξit −1 :
t¼1 t¼1 t¼1 t¼1
The asymptotic distribution of the test statistic λLM depends on the
number of misspecification indicators in zjt. In our case, there were
two misspecification indicators, so we obtained an asymptotic Chi-
square distribution under standard assumptions of two degrees of free-
dom. The rejection of the null hypothesis indicates a risk spillover from
series i to series j.
E. Bouri / Energy Economics 51 (2015) 590–598
5. Estimation results
5.1. Conditional means and variances
ð3Þ Table 3 reports, for the pre- and post-crisis periods, the results ob-
tained from the specification tests in regard to the order of the ARMA,
the type of conditional volatility process, and the probability distribu-
tion. Provided that the conditions of stability and stationarity were
met, the best univariate models were chosen along the lines of Beine
and Laurent (2003) by varying p and q from 2 to 0. As shown in Panel
A, the best univariate model for oil returns was ARMAX(0,0)–GARCH
(1,1) with t-distribution, for Lebanon was ARMAX(0,0)–GJR–GARCH
(1,1) with t-distribution, and for Jordan was ARMAX(1,0)–GARCH
(1,1) with GED distribution. In the aftermath of the crisis, the best uni-
variate model for oil returns was ARMAX(0,0)–GARCH (1,1) with GED
distribution, for Lebanon was ARMAX(0,1)–GARCH (1,1) with GED dis-
tribution, and for Jordan was ARMAX(0,0)–GARCH (1,1) with GED dis-
tribution. Examining the densities, the results show that the GED and
student-t distributions clearly outperformed the normal distribution,
which corroborates the findings of Lundbergh and Terasvirta (2002),
who argue that the assumption of a normal error distribution of a
GARCH-based process is often too restrictive. It is also worth noting
the suitability for capturing the dynamics of Lebanese stock returns in
the pre-crisis period with an asymmetric GARCH model. This suggests
that the conditional second moment responds asymmetrically to nega-
tive versus positive shocks.
Table 4 reports, for the pre- and post-crisis periods, the parameter
estimates for the chosen models for the conditional mean and variance.
Regarding the ARMAX structure, most of the low-order coefficients
were statistically significant at the conventional level in both periods.
The coefficients on the day-of-the-week effects were also generally sig-
nificant at conventional levels (Chau et al., 2014). However, movements
in world stock prices were insignificant in most cases.
ð4Þ Regarding the conditional variances, all the conditions of the
GARCH-based models were satisfied; the constant, ARCH, and GARCH
coefficients were positive, and the sum of the ARCH and GARCH coeffi-
cients was less than unity, indicating that the conditional variance was
stationary over a wide range for all cases. All the coefficients of the
GARCH and ARCH parameters were statistically significant at conven-
ð5Þ tional levels, implying that strong GARCH and ARCH effects were pres-
ent for the return series. The small ARCH values for oil imply that the
conditional variance did not change very rapidly, whereas the larger
ARCH values for Lebanese and Jordanian stock indices suggest high
short-term persistence in the conditional variance. Conversely, the
large GARCH values in the oil market as compared to the lower
GARCH values for both the Lebanese and Jordanian stock markets
imply gradual fluctuations of the conditional variance over time. Put dif-
ferently, there was more persistence in oil variance in the long term. In
the post-crisis period, the GARCH parameters increased in most cases,
implying that the conditional variance took more time to decay as com-
pared to in the pre-crisis period. In all cases, the sum of the ARCH and
GARCH terms was close to 1, implying high variance persistence for
both periods. In the pre-crisis period, the asymmetric term for the con-
ditional volatility of Lebanon was significant at the 1% level, suggesting
that there was a leverage effect in the return series. In order to assess
whether each of the selected models succeeded in addressing the prob-
lem of autocorrelation and heteroskedasticity, we focused on the good-
! ness of fit. In all cases, the Box–Pierce statistics indicate that there was
T
2
no evidence of significant autocorrelation in squared residuals at the
2
t¼1 1% significance level up to 5 and 10 lags. Note also the absence of
heteroskedasticity in the residuals.
5.2. Results of the volatility spillover
After selecting and estimating the best conditional means and vari-
ances for all the return series, the next step consisted of testing for
 E. Bouri / Energy Economics 51 (2015) 590–598 595

Table 3
Specification tests for the conditional means and variances.

Oil Lebanon Jordan

N T GED N T GED N T GED

Panel A: 3 April 2003–30 July 2008

ARMAX(p,q)–GARCH(1,1)
p = 0, q = 0 −4.8967 −4.9092 −4.9072 −5.9819 −6.3284 −6.3241 −5.8376 −6.1763 −6.3727
p = 0, q = 1 −4.8914 −4.9038 −4.9021 −5.9787 −6.3249 −6.3186 −5.8323 −6.1730 −6.4039
p = 0, q = 2 −4.8858 −4.8984 −4.8967 −5.9736 −6.3193 −6.3136 −5.8267 −6.1673 −6.3711
p = 1, q = 0 −4.8912 −4.9036 −4.9018 −5.9781 −6.3246 −6.3186 −5.8324 −6.1731 −6.4078
p = 1, q = 1 −4.8919 −4.9049 −4.9024 −5.9745 −6.3210 −6.3140 −5.8346 −6.1676 −6.3647
p = 1, q = 2 −4.8863 −4.8993 −4.8968 −5.9690 −6.3155 −6.3132 −5.8289 −6.1620 −6.3977
p = 2, q = 0 −4.8858 −4.8986 −4.8967 −5.9731 −6.3191 −6.3140 −5.8267 −6.1674 −6.3978
p = 2, q = 1 −4.8863 −4.8993 −4.8968 −5.9691 −6.3254 −6.3083 −5.8289 −6.1620 −6.3742
p = 2, q = 2 −4.8808 −4.8919 −4.8914 −5.9931 −6.3241 −6.3042 −5.8244 −6.1586 −6.3779

ARMAX(p,q)–GJR–GARCH(1,1)
p = 0, q = 0 −4.9083 −4.9147 −4.9136 −5.9822 −6.2118 −6.3217 −5.8384 −6.1707 −6.3367
p = 0, q = 1 −4.9031 −4.9093 −4.9083 −5.9797 −6.2100 −6.3165 −5.8331 −6.1674 −6.3872
p = 0, q = 2 −4.8975 −4.8909 −4.8877 −5.9746 −6.2044 −6.3112 −5.8275 −6.1617 −6.3965
p = 1, q = 0 −4.9029 −4.9091 −4.9081 −5.9790 −6.2097 −6.3164 −5.8331 −6.1674 −6.3726
p = 1, q = 1 −4.9041 −4.8959 −4.8924 −5.9755 −6.2048 −6.3115 −5.8343 −6.1620 −6.2963
p = 1, q = 2 −4.8984 −4.9048 −4.9034 −5.9699 −6.1992 −6.3061 −5.8286 −6.1563 −6.3432
p = 2, q = 0 −4.8974 −4.9039 −4.8879 −5.9740 −6.2041 −6.3112 −5.8276 −6.1618 −6.3808
p = 2, q = 1 −4.8984 −4.7309 −4.9034 −5.9699 −6.1992 −6.3061 −5.8286 −6.1563 −6.3634
p = 2, q = 2 −4.8931 −4.8993 −4.8985 −5.9940 −6.2060 −6.3065 −5.8247 −6.1596 −6.3481

Panel B: 1 August 2008–11 December 2013

ARMAX(p,q)–GARCH(1,1)
p = 0, q = 0 −5.0633 −5.0810 −5.0834 −7.3654 −7.5063 −7.5045 −6.1648 −6.4278 −6.5636
p = 0, q = 1 −5.0576 −5.0754 −5.0778 −7.3684 −7.5066 −7.5047 −6.1594 −6.4221 −6.5562
p = 0, q = 2 −5.0520 −5.0697 −5.0723 −7.3628 −7.5009 −7.4991 −6.1538 −6.4165 −6.5517
p = 1, q = 0 −5.0577 −5.0754 −5.0778 −7.3684 −7.5065 −7.5046 −6.1598 −6.4221 −6.5551
p = 1, q = 1 −5.0530 −5.0700 −5.0723 −7.3628 −7.5009 −7.4991 −6.1685 −6.4240 −6.5520
p = 1, q = 2 −5.0474 −5.0645 −5.0669 −7.3585 −7.4141 −7.4954 −6.1643 −6.4185 −6.5463
p = 2, q = 0 −5.0520 −5.0697 −5.0723 −7.3634 −7.5010 −7.4990 −6.1542 −6.4165 −6.5518
p = 2, q = 1 −5.0474 −5.0645 −5.0669 −7.3584 −7.4954 −7.4948 −6.1640 −6.4184 −6.5458
p = 2, q = 2 −5.0451 −5.0610 −5.0620 −7.3555 −7.4963 −7.4974 −6.1604 −6.4223 −6.5372

ARMAX(p,q)–GJR–GARCH(1,1)
p = 0, q = 0 −5.0728 −5.0856 −5.0889 −7.3630 −7.5007 −7.4990 −6.1767 −6.4311 −6.5561
p = 0, q = 1 −5.0672 −5.0800 −5.0833 −7.3654 −7.5010 −7.4991 −6.1713 −6.4254 −6.5565
p = 0, q = 2 −5.0615 −5.0744 −5.0779 −7.3599 −7.4953 −7.4935 −6.1657 −6.4198 −6.5515
p = 1, q = 0 −5.0671 −5.0800 −5.0833 −7.3653 −7.5009 −7.4990 −6.1715 −6.4254 −6.5542
p = 1, q = 1 −5.0625 −5.0747 −5.0777 −7.3598 −7.4953 −7.4935 −6.1797 −6.4252 −6.5518
p = 1, q = 2 −5.0569 −5.0692 −5.0725 −7.3548 −7.5085 −7.4897 −6.1755 −6.4197 −6.5455
p = 2, q = 0 −5.0615 −5.0744 −5.0779 −7.3603 −7.4954 −7.4934 −6.1659 −6.4198 −6.5478
p = 2, q = 1 −5.0569 −5.0691 −5.0724 −7.3550 −7.4898 −7.4890 −6.1751 −6.4197 −6.5462
p = 2, q = 2 −5.0535 −5.0645 −5.0670 −7.3534 −7.4907 −7.4920 −6.1730 −6.4247 −6.5267

Notes: In this table, the upper panel reports the values of the SIC across the various ARMA specifications using a standard GARCH (1,1) specification with three probability distributions,
whereas the lower part gives the same statistics using the asymmetric GJR–GARCH model with three probability distributions. Bold numbers designate the best models. Provided that the
conditions of stability and stationarity were filled, the best specifications were chosen on the basis of SIC values.

volatility spillovers using the principle of LM as developed by Hafner
and Herwartz (2006). Table 5 reports the results of the test for causality
in variance between the world oil market and the stock markets of
Lebanon and Jordan before and after the global financial crisis.
5.2.1. Volatility spillover between oil and Lebanon
For the case of Lebanon, there were no volatility spillovers in any di-
rection before or after the crisis. This finding, which points to the exis-
tence of a diversification possibility between the global oil market and
Lebanese stock markets, does not reflect the dominance of the risk
and information flow from the largest commodity market to the stock
markets of small economies (Arouri et al., 2011). In other words, the re-
cessionary economy and the shrinking demand for crude oil did not in-
tensify the information linkages between the oil market and the
Lebanese stock market. This finding adds to the weak evidence of return
and volatility linkages documented by Bouri (2015). To some extent, the
lack of evidence on the volatility spillovers from crude oil prices to the
Lebanese stock index is not surprising, given that the Lebanese market
is dominated by banking and services companies, which are weakly de-
pendent on oil market conditions. In particular, the lack of a liquid stock
market in Lebanon was an additional hurdle to significant volatility
spillovers, and this probably has led to an insignificant role played by
GCC investors in the joint dynamics of volatility.
5.2.2. Volatility spillover between oil and Jordan
For the case of Jordan, there were no volatility spillovers in any direc-
tion in the pre-crisis period. For the post-crisis period, however, there
was significant evidence supporting the existence of a two-way volatil-
ity spillover effect between the world oil market and the Jordanian stock
market. It seems that the vulnerability of both the oil and stock markets
to the recessionary shock in the aftermath of the crisis intensified the in-
formation and risk flow linkages (Awartani and Maghyereh, 2013). The
results show that there was a volatility spillover from crude oil to
Jordanian stocks at the 1% significance level. This result is not surprising
in view of the dominant role of oil in the volatility discovery process of
GCC stock markets, in particular during crisis periods under the effects
of economic and financial instability (Arouri et al., 2011; Jouini and
Harrathi, 2014). The most interesting result is the volatility spillover
from the Jordanian stock market to the world oil market, even though
it was only significant at the 10% level. One explanation for this could
be related to the considerable presence of GCC investors in the
Jordanian stock market and to the role of the financial crisis. The latter
596 E. Bouri / Energy Economics 51 (2015) 590–598

Table 4 Table 5
Estimation of the selected ARMAX–GARCH/ARMAX–GJR–GARCH models. Causality-in-variance test.

3 April 2003– 1 August 2008– 3 April 2003–30 1 August 2008–11

30 July 2008 11 December 2013 July 2008 December 2013

Oil Oil variance does not cause Lebanon 2.1584 3.8054

Mean equation variance
Constant 0.0038⁎⁎⁎ −0.0024⁎⁎⁎ Lebanon variance does not cause oil 0.1275 1.0318
W(−1) 0.1184⁎⁎⁎ 0.0814⁎ variance
D1 −0.0048⁎⁎⁎ 0.0037⁎⁎ Oil variance does not cause Jordan 1.3046 9.2542⁎⁎⁎
D2 −0.0034⁎⁎ 0.0035⁎⁎⁎ variance
D3 −0.0046⁎⁎⁎ 0.0037⁎⁎⁎ Jordan variance does not cause oil 0.6491 6.3086⁎
D4 0.0005 0.0034⁎⁎ variance
Variance equation
⁎⁎⁎ Indicates statistical significance at the 1% level.
Constant 6.665E-06 1.91E-06
⁎ Indicates statistical significance at the 10% level.
ARCH 0.0129⁎⁎⁎ 0.0511⁎⁎⁎
GARCH 0.9709⁎⁎⁎ 0.9437⁎⁎⁎
GED parameter – 1.4424⁎⁎⁎
Student (DoF) 11.9650⁎⁎⁎ – triggered a withdrawal of foreign investors from Jordan, suggesting that
Model diagnostics
enormous spikes in oil price volatility worried investors in Jordan, and
Q-squared (5) 1.5907 3.1467
Q-squared (10) 15.5610 4.4901 this in turn led to more-significant volatility spillovers in the pre-crisis
ARCH(5) 0.9078 0.6597 period. The higher liquidity and more diversified sectorial structure in
ARCH(10) 0.1156 0.9185 the frontier market of Jordan probably made the two-way volatility
Lebanon spillover easier. This pattern in the volatility spillover found in Jordan
Mean equation is quite similar to that found by Awartani and Maghyereh (2013), who
Constant 0.0009⁎ −0.0001 report bi-directional and asymmetric volatility transmissions between
MA(1) – 0.0776⁎⁎⁎
oil and stocks in GCC countries.
Jordan(−1) 0.0117 0.0035
W(−1) −0.0209 0.0107
Our methodology, which has captured many of the salient features
D1 −0.0006 −0.0007⁎⁎ of the data, enabled us to improve the assessment of cross-market vol-
D2 −0.0014⁎⁎ −0.0003 atility spillovers. From a risk management perspective, this would avoid
D3 3.18E-05 0.0001 probable spurious results of the causality-in-variance test due to unob-
D4 −0.0005 −0.0003
served features of the data or GARCH specification bias. Given that most
Variance equation
Constant 8.77E-06⁎⁎⁎ 1.01E-06⁎⁎⁎ investment and regulatory decisions rely critically on the assessment of
ARCH 0.3165⁎⁎⁎ 0.1532⁎⁎⁎ risk, ignoring the role played by oil price volatility in explaining the con-
GARCH 0.6743⁎⁎⁎ 0.8337⁎⁎⁎ ditional volatility of the Jordanian stock market would place financial
Asymmetric −0.1501⁎⁎⁎ –
practitioners and policymakers at risk of making inefficient econometric
term
GED parameter – 1.0416⁎⁎⁎
inferences and inaccurate forecasts of volatility. For financial practi-
Student (DoF) 10.0000⁎⁎⁎ – tioners, such ignorance would particularly undermine the diversifica-
Model diagnostics tion benefits of holding oil in a portfolio and would withhold reliable
Q-squared (5) 4.0770 0.6459 analytics on pricing financial derivatives and on measuring the value
Q-squared (10) 8.2739 8.1089
at risk. It would also lead to errors in the construction of efficient port-
ARCH(5) 0.5631 0.9874
ARCH(10) 0.6754 0.6444 folios. For policymakers, such ignorance would lead to the formulation
of mistaken policies that are probably decoupled from oil price volatili-
Jordan
ty. These may include the continuation of the current systematic policy
Mean equation
Constant 1.47E-09 2.42E-08 of heavy dependence on oil imports and the postponement of the adop-
AR(1) 5.37E-08 – tion of energy-efficient technologies.
Lebanon(−1) 1.35E-07 −9.37E-06
W(−1) −8.37E-07 −3.59E-06
D1 0.0028⁎⁎⁎ −0.0004⁎⁎⁎ 5.2.3. Economic significance
D2 0.0009⁎⁎⁎ −7.26E-05
Regarding the economic magnitude of the risk spillover from the
D3 −3.41E-10 −0.0017⁎⁎⁎
D4 0.0010⁎⁎⁎ −8.55E-05⁎⁎⁎ world oil market to the Jordanian stock market for the sake of investors
Variance equation and policymakers, we next considered the impact of this risk spillover
Constant 2.57E-05⁎⁎ 5.97E-06⁎⁎⁎ on the prices of stock index options (see Table 6). In the absence of
ARCH 0.1650⁎⁎ 0.1141⁎⁎⁎
risk spillover from the crude oil market, the baseline Black–Scholes
GARCH 0.7524⁎⁎⁎ 0.8772⁎⁎⁎
GED parameter 0.5347⁎⁎⁎ 0.5732⁎⁎⁎
price of an at-the-money call option on the Jordanian stock index with
Model diagnostics annualized volatility of 8.70% and maturity of 12 months stood at
Q-squared (5) 3.3895 3.9880 $6.355. With a hypothetical volatility spillover from oil to Jordanian
Q-squared (10) 11.3710 10.9220 stocks in the post-crisis period of 10%, which translated into an
ARCH(5) 0.6545 0.5745
ARCH(10) 6.3709 0.4044
Table 6
Notes: D denotes dummy variables for the day-of-the-week effects; W denotes world
Economic magnitude of the risk spillover in Jordan.
market return; Student (DoF) indicates the student-t distribution parameter; the ARCH–
LM statistic tests the null hypothesis of no conditional heteroskedasticity up to 5 and 10 No spillover from crude oil With 10% spillover from crude oil
lags; and the Box–Pierce Q-squared statistic tests the null hypothesis of no autocorrelation
up to order 5 and 10 for squared values. Jordanian stock market Call Jordanian stock market Call
⁎⁎⁎ Indicates statistical significance at the 1% level. volatility price volatility price
⁎⁎ Indicates statistical significance at the 5% level. 8.70% 6.355 9.80% 6.762
⁎ Indicates statistical significance at the 10% level.
Notes: Risk-free rate = 4.90% (Central bank of Jordan), MSCI Jordan on 11 December 2013 =
100.856, strike price = 100.856, time to expiration = 12 months, dividend yield = 0%.
qffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffipffiffiffiffiffiffiffiffi
Annualized Jordan conditional volatility ¼ σ 2MSCI Jordan þ Oil spillover 252.
 E. Bouri / Energy Economics 51 (2015) 590–598
Table 7
Causality-in-variance test — Tunisia and Morocco.
3 April 2003–30 July 2008
Oil variance does not cause Tunisia variance 1.3627
Tunisia variance does not cause oil variance 2.8480
Oil variance does not cause Morocco variance 0.3056
Morocco variance does not cause oil variance 2.5739
⁎ Indicates statistical significance at the 10% level.
annualized Jordanian stock index volatility of 9.80%, the option price in-
creased from $6.355 to $6.762. In other words, a 1% spillover induced an
increase in the cost of the call option by 0.640% from the baseline during
the period 1 August 2008–11 December 2013.
5.3. Additional analysis
To better illustrate the seemingly contradictory effects of being an oil
importer while having investors from oil-exporting countries, we used
the same empirical model and compared our initial results and the
below results (reported in Table 7) from other small oil-importing
countries that do not have as many investors from oil-exporting coun-
tries. As suggested by one of the reviewers, this would better demon-
strate why a general audience may be interested in Lebanon and
Jordan. To this end, we chose the stock markets of Tunisia and
Morocco, both of which are somewhat similar in size to Lebanon and
Jordan, whereas they are less appealing to GCC investors (Fitch,
2011). In addition, Tunisia and Morocco are less-energy-intensive
economies than Lebanon and Jordan are. However, they have
more-liquid stock markets. In particular, the stock markets of
Tunisia and Morocco have long positioned themselves as receptive
to European investment and tourism.
Unlike the empirical analysis of Lebanon and Jordan, we kept the
comparison simple and only explored the extent to which oil price vol-
atility is transmitted to the stock markets and vice versa. Since we
intended not to make the paper longer and more complex in unneces-
sary aspects, we report in Table 7 only the results of the test for causality
in variance between the world oil market and the stock markets of
Tunisia and Morocco before and after the global financial crisis. However,
we followed the same empirical framework that was used earlier in the
cases of Lebanon and Jordan (see the appendix). The summary statistics
and stylized facts of the daily returns for the Tunisian and Moroccan
stock indices during the pre- and post-crisis periods were quite similar
to those of the Lebanese and Jordanian stock market returns in regard
to departures from normality, autocorrelation, and heteroskedasticity.
In the pre-crisis period, the results from the estimation of the best
ARMAX–GARCH-based models indicate that the best univariate model
for Tunisia was ARMAX(2,0)–GARCH (1,1) with t-distribution and for
Morocco was ARMAX(1,0)–GARCH (1,1) with GED distribution. After
the crisis, the best univariate model for Tunisia was ARMAX(0,1)–GJR–
GARCH (1,1) with t-distribution and for Morocco was ARMAX(0,1)–
GARCH (1,1) with GED distribution. As shown in Table 7, there were
no risk spillovers in any direction in the pre-crisis period. After the crisis,
however, only oil transmitted its volatility to the Tunisian stock market
at the 10% significance level. Given that the economies of Tunisia and
Morocco are less energy intensive and their stock markets are more
liquid compared to those of Lebanon and Jordan, we argue that this
weak evidence of volatility spillovers was probably due to the weak
role of GCC investors in conceiving significant (beyond the 10% level)
risk dynamics between the world oil market and the stock markets of
Tunisia and Morocco.
However, the analysis detailed above failed to account for any
potential role of European investors in shaping the volatility dynamics
between crude oil prices and stock market returns in Tunisia and
Morocco. This could be examined in future studies.
597
1 August 2008–11 December 2013
6.9237⁎
0.3940
0.1780
1.3413
6. Concluding remarks
Given that changes in volatility reflect the arrival of new information
to a market, it is crucial to unravel volatility spillovers between oil and
stock markets for constructing portfolios, for asset pricing, and for vola-
tility forecasting. Unraveling the nature of intermarket information
flows is also of paramount importance in risk management, as it can
help to determine the optimal hedge ratio and the value-at-risk mea-
sure. In contrast with most of the existing literature, this paper explores
the extent to which oil price volatility is transmitted to the stock mar-
kets of two heavily oil-importing countries – namely Lebanon and
Jordan – which are characterized by their locations in a region with a
large number of oil-exporting countries, so their stock markets are
somewhat tied to oil exporters by way of foreign investors. In addition
to the particularity of the research context, this study employed
the LM test for causality in variance of Hafner and Herwartz
(2006) to examine the inner volatility dynamics of the oil and
stock markets in pre- and post-crisis periods. The LM test followed
the estimation of a univariate model that included an ARMAX struc-
ture for the conditional mean and a GARCH specification for the
conditional variance.
The empirical applications produced several interesting findings.
While the stock markets of Lebanon and Jordan in the pre-crisis period
showed no response to oil volatility shocks, it was clear that they
responded differently to oil volatility shocks in the post-crisis period.
For the case of Lebanon, the stock market volatility continued to behave
independently from that of the oil market in the pre-crisis period. In this
regard, declining oil prices after the crisis failed to create a new source of
uncertainty for portfolio managers and regulators. This result suggests
that there remains much potential to diversify in the oil and Lebanese
stock markets. For the case of Jordan, however, oil volatility shocks
after the crisis seemed to have a significant impact on the causal re-
lationship in volatility between the world oil market and the stock
market of Jordan (Arouri et al., 2011), whereas the feedback effect
was much weaker. Overall, this result brought to light the predictive
power of oil volatility in forecasting the volatility in the Jordanian
stock market in the post-crisis period, suggesting a reduction in di-
versification possibilities.
In addition, we highlighted the differences in the ways the stock
markets of Lebanon and Jordan have responded to oil price volatility
compared to other small and heavily oil-importing countries (Tunisia
and Morocco), suggesting a substantial heterogeneity of the volatility
dependence patterns within these two groups of oil-importing MENA
countries. The fact that oil volatility played a very weak role in
predicting the stock market volatility in Tunisia and Morocco manifests
the insignificant role played by GCC foreign investors in the volatility
structure compared to in the cases of Lebanon and Jordan. Put different-
ly, this implies that the presence of foreign investors from oil exporters
can engender higher inconsistency in how the stock markets of small
oil-importing MENA countries respond to oil volatility shocks.
Our empirical findings improve the basic understanding of whether
the volatility of crude oil prices causes price volatility in the stock mar-
kets of Lebanon and Jordan and therefore should be of interest to market
participants and academic researchers, not only because these matters
affect the decisions made by policymakers in energy risk planning but
also because they influence portfolio managers' decisions in portfolio
598 E. Bouri / Energy Economics 51 (2015) 590–598
allocation and risk management. The Jordanian government is interest-
ed in promoting the stability and development of its domestic stock
market; it should therefore establish an adequate surveillance system
that has the ability to monitor market situations and a circuit breaker
capable of quickly responding to oil volatility shocks, particularly during
crisis periods (Aloui et al., 2013). In view of the global financial crisis, it
is evident that the transmission of information between the world oil
market and stock markets was on the rise.
Despite the above noteworthy findings and their subsequent practi-
cal implications, further research is still needed to more explicitly exam-
ine the role of stock market depth and foreign ownership on the nature
of volatility dynamics between the world oil market and the stock
market activities of oil-importing countries.
Appendix A. Supplementary data
Supplementary data to this article can be found online at http://dx.
doi.org/10.1016/j.eneco.2015.09.002.
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