Stock Prices , Exchange Rates , and Oil : Evidence from Middle East Oil - Exporting Countries

We consider the linkage between stock prices and exchange rates in four Middle East emerging markets. The existing evidence on stock prices and exchange rates typically relies on introduction of a global market index. On the contrary, we find that for the countries of our sample oil prices emerge as the dominant factor in the above relationship. When we focus on the extended sample we do not detect evidence of cointegration between stock prices and real exchange rates, or of cointegration among stock prices, real exchange rates and other exogenous variables such as the US stock price or the oil price. To address the possibility that this finding may be due to the presence of regime shifts we, first, divide the sample into two subperiods based on the oil price shock in March 1999. The Johansen trace statistics reveals evidence of cointegration only for the second subsample, among stock prices, real exchange rates and oil prices in Egypt, Oman and Saudi Arabia, and between stock prices and oil prices in Kuwait. Utilizing the full sample and including deterministic dummies in the VECM we attempt to capture the regime shifts. The FIML estimation results corroborate the finings from splitting the sample, indicating that the oil prices have a longrun positive effect on stock market in each country. Readjustment towards the long-run equilibrium in each stock market occurs via oil price changes. Finally, we produce persistence profiles showing that convergence to the long run equilibrium takes 17 and 14 months in Egypt and Saudi Arabia respectively, while it takes 22 and 24 moths in Oman and Kuwait. * (Corresponding Author) School of Accounting Finance and Management, University of Essex, Wivenhoe Park, Colchester, UK. Email: [email protected] ** Department of Economics, University of Athens, Athens 0559, Greece. Phone: 30 (210) 3689805. Email: [email protected] ***Department of Social Cognitive and Quantitative Sciences, University of Modena and Reggio Emilia, viale A. Allegri, 9, 42100 Reggio Emilia, Italy. Email: [email protected] Topics in Middle Eastern and African Economies Vol. 10, Sept 2008