Assessing the impacts of oil price fluctuations on stock returns in emerging markets Chaker Aloui a , Duc Khuong Nguyen b, ⁎, Hassen Njeh c a College of Business and Administration, King Saud University, KSA b ISC Paris School of Management, France c International Finance Group, University of Tunis El Manar, Tunisia abstract article info Article history: Accepted 10 August 2012 JEL classification: G15 F30 Q40 Keywords: Oil shocks Emerging market returns Multifactor pricing model Long-term correlations This paper investigates the effects of oil price shocks on stock market returns in emerging countries. It differs from previous works in three main aspects: i) we distinguish three groups of countries, the largest net-oil importing countries, the moderately oil-dependent countries, and the largest net-oil exporting countries; ii) The potential influence of bullish and bearish market conditions on the causal relationship between oil and stock returns is controlled for in our analysis; iii) The empirical investigation is based on an analysis of long-term correlation and a conditional multifactor pricing model. Using data from twenty-five emerging countries, our results suggest that oil price risk is significantly priced in emerging markets, and that the oil impact is asymmetric with respect to market phases. © 2012 Elsevier B.V. All rights reserved. 1. Introduction Oil price movements are always closely watched by policymakers and investor community as oil is considered as an important driver of the economic and industrial activity. Since there is now evidence to show that oil prices negatively affect economic growth through a number of channels such as rising production cost, inflation, and investor confidence (e.g., Hamilton, 2003; Kilian, 2008; Lardic and Mignon, 2008), one would expect some degree of interdependence between oil prices and stock market performance (Huang et al., 1996). Further, for portfolio managers and in particular global inves- tors seeking for international diversification benefits by adding assets of emerging markets into their portfolios, new insights about the impact of oil on the equity's risk-return profile in these markets are of paramount important as they can properly manage the risk inher- ent to their portfolios. Analyzing the effects of oil price volatility on the behavior of emerging stock markets is a main research question given that most of emerging economies have expanding energy demand to build their infrastructure and to insure their rapid economic growth. Several indications may approve this argument. First, in contrast to previous cri- sis periods, economic growth in emerging countries outperformed growth in developed economies during the recent international financial crisis, sparked off by the U.S. subprime crisis. With reference to official statistics by the International Monetary Fund, the GDP of developed countries in 2009 declined -3.6% on average, while the GDP in emerging countries grew by 1.7%. In addition, some further fore- casts indicate that emerging economies will account for about 50% of the global GDP by 2050 and be a predominant driving force for the world economic growth (Cheng et al., 2007). It should be stressed that over the period 1990–2005 China and India exhibited a higher rate of growth than the major OECD countries. These two countries grew at av- erage annual rates of 7.7% and 7.2% respectively, while OECD economies only reached an average annual rate of 2.5% during the same period. Along with this rapid economic growth within the emerging universe and especially in India, China, Brazil and Russia (BRIC), global demand for oil grew annually by an average of 1,153 million barrels per day over the period 2001–2010. 1 In this paper, we attempt to examine the extent to which emerg- ing market returns are associated with oil price fluctuations. As discussed above, the fast economic growth of emerging economies over the recent decades suggests that they consume an important quantity of energy and may thus be heavily dependent oil production and supply. Unfavorable changes in oil prices would reduce their eco- nomic performance, leading to lower their diversification benefits be- cause of less cash-flow generated by firms' activities. On the other hand, the heterogeneity of emerging markets in terms of economic structure, economic and market development levels as well as Economic Modelling 29 (2012) 2686–2695 ⁎ Corresponding author at: 22 Boulevard du Fort de Vaux, 75017 Paris, France. Tel.: +33 1 4053 9999; fax: +33 1 4053 9898. E-mail addresses: chakeraloui2@yahoo.fr (C. Aloui), dnguyen@iscparis.com (D.K. Nguyen), hassen.n@gmail.com (H. Njeh). 1 See BP Statistical Review (2012). 0264-9993/$ – see front matter © 2012 Elsevier B.V. All rights reserved. http://dx.doi.org/10.1016/j.econmod.2012.08.010 Contents lists available at SciVerse ScienceDirect Economic Modelling journal homepage: www.elsevier.com/locate/ecmod