The recent surge in oil prices over the past eight years has generated a lot of interest in the relationship between oil prices, financial markets and the economy (see, for example, Blanchard and Gali, 2007, and Herrera and Pesavento, 2009). Crude oil spot prices, measured using West Texas Intermediate crude oil, closed out the year 2002 at $29.42 per barrel. By the June of 2008 spot oil prices had risen to $133.93 per barrel. Over this same time period, the US dollar fell against other major traded currencies and emerging market stock prices rose (Figure 1).
While there exists a literature on the relationship between oil prices and stock prices, and a separate literature on the relationship between oil prices and exchange rates, the relationship between these two streams has, however, not been that closely studied, especially within the context of emerging market stock prices. The purpose of this paper is to use a structural vector autoregression (SVAR) model to bring these two literatures together.
Understanding the relationship between oil prices, exchange rates and emerging stock market prices is an important topic to study because as emerging economies continue to grow and prosper, they will exert a larger influence over the global economy. By some estimates, emerging economies will account for 50% of global GDP by 2050 (Cheng et al., 2007) and the majority of economic growth. Over the period 1990 to 2005 real GDP in China and India grew at average annual rates of 7.7% and 7.2% respectively. By comparison, OECD countries grew at an average annual rate of 2.5% over this same period.
At these growth rates the Chinese economy will double every 9 years and the Indian economy will double every 10 years. Along with this economic growth comes a voracious demand for energy products such as oil. In 2006, the US was the largest consumer of oil in the world, accounting for 24% of the global oil demand. China, at 9% of the world total, had pushed passed Japan to become the second largest oil consuming nation (Table 1). While the demand for oil in developed economies is holding steady or declining slightly, the demand for oil in emerging economies is rapidly growing.
The International Energy Agency (IEA) (2007, p. 80) predicts that between 2006 and 2030, China and India will have average annual growth rates in oil of 3.6% and 3.9% respectively (compared to the 1.3% average annual growth rate for the world). China and India, combined together will represent 42% of the global increase in oil demand between 2005 and 2030.
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Oil Prices, Exchange Rates and Emerging Stock Markets
