The dependence between international crude oil price and vietnam stock market nonlinear cointegration test approach

MINH CITYHÀ THỊ NHƯ PHƯƠNG THE DEPENDENCE BETWEEN INTERNATIONAL CRUDE OIL PRICE AND VIETNAM STOCK MARKET NONLINEAR COINTEGRATION TEST APPROACH ECONOMIC MASTER THESIS Ho Chi Minh City -20

MINH CITY

HÀ THỊ NHƯ PHƯƠNG

THE DEPENDENCE BETWEEN INTERNATIONAL CRUDE OIL PRICE AND VIETNAM STOCK MARKET NONLINEAR COINTEGRATION TEST APPROACH

ECONOMIC MASTER THESIS

Ho Chi Minh City -2015

MINH CITY

HÀ THỊ NHƯ PHƯƠNG

THE DEPENDENCE BETWEEN INTERNATIONAL CRUDE OIL PRICE AND VIETNAM STOCK MARKET NONLINEAR COINTEGRATION TEST APPROACH

Major: FINANCE - BANKING Code: 60340201

ECONOMIC MASTER THESIS

INTRUCTOR:

Assoc Prof NGUYỄN THỊ NGỌC TRANG

I commit that the economic master thesis titling “the dependence between internationalcrude oil price and Vietnam stock market: Nonlinear cointegration test approach” wasmade by myself with the direction of Associate Professor Nguyen Thi Ngoc Trang Thestudy’s results are truthful and data was collected from the credible sources such as: HoChi Minh City stock exchange, Energy Information Administration, the State Bank ofVietnam and General Statistics Office of Vietnam.

Ho Chi Minh City, October 28th, 2015

Author

HA THI NHU PHUONG

TABLE OF CONTENT

LIST OF ABBREVIATIONS

LIST OF TABLES

LIST OF FIGURES

Abstract 1

1 Introduction 2

2 Literature Review 7

2.1 Literature Review 7

2.1.1 The relationship between crude oil price and stock market 7

2.1.1.1 Negative effect from crude oil price to stock market 7

2.1.1.2 Positive effect from crude oil price to stock market 9

2.1.1.3 Insignificant nexus between oil price and stock market 11

2.1.1.4 The imperial evidences about the relationship between oil prices and Vietnam stock market 12

2.1.2 The relationship between stock market and exchange rate 13

2.2 Overview about Vietnam stock market, oil sector and exchange rate regime 17

2.2.1 Vietnam stock market 17

2.2.2 Oil section 19

2.2.3 Exchange regime 22

3 Data and research methodology 25

3.2.1 Gregory and Hansen Test - GH test 30

3.2.2 Toda-Yamamoto (TY) version of Granger non-causality test 32

3.2.3 Error Correction Model 34

4 Researching result 36

4.1 Descriptive statistics 36

4.2 Unit root test 41

4.3 Gregory and Hansen Test-GH test 45

4.4 TY procedure of Granger non–causality test 46

4.5 Error correction model 49

5 Conclusion 51

References

Appendices

bbl/d Barrels per day

The five permanent members of the United Nations Security

VN index for the entire sample 38

Table 4.2 Descriptive statistic of three variables, exchange rate, crude oil price and VN index for four phases 40

Table 4.3 Unit root test result for entire sample 43

Table 4.4 Unit root test result for four phases: 44

Table 4.5 Threshold cointegration results 45

Table 4.6 Critical values of GH test with significant level at 5% and 3 regressors 45

Table 4.7 TY version of Granger non–causality tests 48

Table 4.8 Error correction model 49

LIST OF FIGURES Figure 1.1 Global crude oil and petroleum liquids consumption, supply and inventory in 2014 and 2015 (Source: Energy Information Administration) 2

Figure 1.2 Crude oil export revenues and productions from 2009 to 08 months of 2015 (source: General Statistics Office of Vietnam) 4

Figure 2.1 Vietnam Stock market capitalization to GDP (%) from 2004-2014 (Source Federal Reserve Economic Data) 18

Figure 2.2 Proportion of sectoral market capitalization in 2015 (source: HOSE website) 19

Figure 2.3 Average interbank exchange rates from 2006 to 2015 23

Figure 3.1 Graphical presentation of the series for first phase 26

Figure 3.2 Graphical presentation of the series for the second phase 27

Figure 3.3 Graphical representation of the third phase 28

Figure 3.4 Graphical representation of the fourth phase 29

Figure 3.5 Graphical representation of the entire sample 29

on Vietnam stock market, and there is a balance between benefits and damages inthis period ECM model indicates that oil prices and stock prices have a positiverelationship in short term, and the speed of adjustment of stock price to return theequilibrium state after a shock is slow around 0.25% These findings also have animportant policy implication that helps the government intercept the market toreduce the negative effect from the energy shocks in general and oil price shocks inparticular Those are to pay more attention to domestic production and traderevenues to get more stable budget, research the alternative energy and enhanceinternational cooperation in the energy sector.

Key words: Oil price, stock market, threshold cointergration.

1 Introduction

The oil crude prices has fallen less than $50 per barrel, about 50% of August 2015.The main reason is the oil supply more than demand (see the figure 1) Growing oilinventories and supply typically put downward pressure on near-term prices TheUnited States discovered and applied the new oil drill technology, called “shale oilrevolution” This pushes the oil production is near 10 million barrels per day Sothat it can be offset the substantial oil supply disruption in the Organization of thePetroleum Exporting Countries (OPEC) However, the resumption of significantLibyan oil production, combined with the weakening outlook for global oil demand,the large economies in the word such as China, Russia, Europe area show not goodperformances about industrial production and expectation for economic growth

Figure 1.1 Global crude oil and petroleum liquids consumption, supply and

inventory in 2014 and 2015 (Source: Energy Information Administration).

On July 14, the P5+1 (the five permanent members of the United Nations SecurityCouncil and Germany) and Iran announced an agreement that could result in relieffrom United States and European Union nuclear-related sanctions (which includesome oil-related sanctions) If the agreement is implemented and sanctions reliefoccurs, it will put additional Iranian oil supplies on a global market that has already

seen oil inventories raise significantly over the past year All things have putdownward pressure on oil prices.

Vietnam is net exporter of crude oil, but is a net importer of oil products, thevolatilities in crude oil prices or costs of raw materials should affect to revenueresource of state budget and economic growth Volatilities of world crude oil pricecan affect negatively or positively to profit outlooks of the listed companies onVietnam stock market The companies have inputs from the oil waste products (such

as PLV-Petrolimex Petrochemical Corporation, BMP - Binh Minh Plastic JointStock Company, ) and other companies have input coming directly from thepetroleum sector (PVT- PetroVietnam Transportation Corporation, PVS -PetroVietnam Technical Services Corporation, PVC - Drilling Mud Joint StockCorporation, GAS - PetroVietnam Gas Corporation) are likely to be impactednegative by the decrease of oil price

The figure 1.2 shows that revenues and productions from 2009 -2015 The crude oilprices have decreased since third quarter in 2014, strongly affecting to crude oilrevenues in 2015 although the export productions is bigger than the same period

We are the one of emerging country and its economy depends very large in exportactivities The decline of crude oil price will impact to budget revenues and deficit

Energy, in particular crude oil has played an important role in our economy Thepurpose of this study is to investigate the relationship between crude oil price andVietnam stock market In this paper, I will answer this question from severalperspectives:

(i) Does it exist a long-run relationship between crude oil prices, stock prices and exchanges rates in entire sample?

(ii) Do the big world events such as the financial crisis in 2007 and the technology shock called “shale oil revolution” affect to the co-movement of the three?

(iii) Can the prior values of crude oil prices predict the future values of stock prices

or crude oil prices do Granger cause to stock prices?

(iv) Can the exchange rates do Granger cause to stock prices?

(v) Is the crude oil price an exogenous variable?

(vi) How does the impact of crude oil prices, exchanges rates on stock prices? AndHow adjusted speed of stock prices to return the equilibrium if having a shock in present?

F2b Crude oil export production

(unit: $1billion ton) Figure 1.2 Crude oil export revenues and productions from 2009 to 08 months of

2015 (source: General Statistics Office of Vietnam).

The study will provide investors the market outlook in the future before the oil pricefluctuations in the present Therefrom the investor can make the appropriatehedging strategies and diversification Specially, for a country which the foreigncurrency primarily comes from exporting natural resources such as coals, oil …like

us, then the strong oil price volatilities will snappily impact its internationalbalances, budget deficits and economic growth rates Through this study, I hope toprovide further evidences about the energy importance to the economy and suggestsolutions that government can intercept to reduce marker volatilities

The study uses the daily data with the period spanning from 01/03/2006 to08/31/2015 Year 2006 chosen is the beginning study year, because Vietnam stockmarket has just had steps on obvious development in numbers of listed companiesand trading volume, and can reflect partly economic situation The entire samples isdivided into 04 phases, the first phase from 01/03/2006 to 12/28/2007 , the secondphase from 01/02/2008 to 12/31/2009, the third phase from 01/04/2010 to06/30/2014 and the last phase from 07/01/2014 to 08/31/2015, attaching with thesignificant decline in oil prices since the beginning of July 2014 due to excessive oilsupply while the world economy is still gloomy and has not yet recovered.

Threshold cointegration test of Gregory and Hansen (1996) is employed test thelong-term relationship of oil prices, exchange rates and stock prices From theresult’s GH test indicate there exists the long run nexus between these variables.Interesting however, the null hypothesis of no co integration cannot reject atsignificant level 5% in all four phases This does prove that events in the researchstage impact the long-term structure of oil prices and the stock market Theinterruptions make them impossible to reach the equilibrium in the limited time ofsubsample

Using the T-Y version of Granger non-causality test proposed by Toda-Yamamoto(1995) shows that there exists a unidirectional relationship, running from oil prices

to stock prices in the entire sample, and the second and third phase These are in andafter the 2007 financial crisis In contrast to my expectation, the crude oil pricesinsignificantly cause Granger to stock price in the last phase The effects of oil price

on stock market maybe need several lags and this phase is not long enough to seethem Besides that, some industries take benefits and some industries bear damagesfrom the decline of oil prices, maybe there has the balance between benefits anddamages in this period

Error Correction Model indicates that oil prices and stock prices have a positiverelationship in short term The reason may come from the oil industry’s stocks have

large market capitalization and significant impact to the market index The decline

of oil prices will lead these stocks of these companies plummet, market sentiment inthe short term push the market index decrease However, the exchange rates don’taffect the stock market in the short term The speed of adjustment of stock price toreturn the equilibrium state after a shock is slow around 0.25%

The study also suggest some policies that help the government intercept the market

to reduce the negative effect from the energy shocks in general and oil price shocks

in particular Those are to paying more attention to domestic production and traderevenues to get more stable budget, research the alternative energy and enhanceinternational cooperation in the energy sector

The outline of this study is structured as follow: Section 1 introduction; section 2literature reviews and overall about Vietnam stock market, oil sector, and Exchangeregime; section 3 data and research method; section 4 researching result and section

5 conclusion

2 Literature Review

There are many papers investigating on the relationship between oil prices and stockprices However, the results of studies are not consistent; the differences depend onthe features of each economy I classify the literature review of the nexus betweenstock prices and oil prices into three sections: (1) negative effect, (2) positive effectand (3) insignificant effect

2.1 Literature Review

2.1.1 The relationship between crude oil price and stock market

2.1.1.1 Negative effect from crude oil price to stock market

Chen 2010 investigates whether the high oil price can lead the stock market into the

bear territory or a recession of the stock market He uses monthly data from1957M1 to 2009M5, including returns on Standard & Poor’s S&P 500 price is aproxy of stock market returns and oil price shocks are measured in differentmethods: changes in oil prices, oil price increases, net oil price increases, and scaledoil price increases In this paper, he employs a time-varying transition-probability(TVTP) Markov-switching model, which allows the probability of switchingbetween states (bull markets vs bear markets) to characterize the fluctuations in thestock market and to identify the impact of oil prices on the switching betweenstages The empirical evidences show that an increase in oil prices leads to a higherprobability of a bear market emerging

Juncal and Fernando (2013) examine the impact of oil price shocks on stock

returns in 12 oil importing European economies using Vector Autoregressive(VAR) and Vector Error Correction Models (VECM) for the period 1973M2 –2011M12 The oil price shocks was divided into 02 kinds, they are oil supply andoil demand shocks, which are measured by world oil production and world oilprices respectively Moreover, there are other explanation variables added to modelssuch as industrial production indexes, short-term interest rates in order to express

different channels through which oil prices could affect stock returns The maincontribution is identification that stock returns may respond in different ways tosupply and demand shocks The oil supply shocks tend to have a greater negativeimpact on stock market returns than oil demand shocks Generally, the oil pricechange lowers economic activity in oil importing economies because of moreexpensive energy inputs However, if the increase comes from demand shock, theneconomic activity in oil importing economies can be impacted negative (due tohigher production cost ) or positive (due to increase world income andconsumption).

Rumi et al (2011) aims to how important the oil price changes and oil price

volatility impact on Korean stock market – a net oil - importing country The modelused is VECM with monthly observations from May 1988 to January 2005 ofinterest rates, industrial production, real stock returns, real oil prices and oil pricevolatility In which, the oil prices and interest rate are exogenous variables Theresult of paper shows that there exists the long – run and stable relationship betweenfour variables, especially, oil price movement has significant effect on stock returnsand the real stock returns are the main channel of short-run adjustment to long-runequilibrium The oil price changes have two ways to impact to firm profitability;those are through production cost and investor sentiment to stock market index.Besides that, authors also suggest three solutions coping with high and volatile oilprices such as increasing government’s strategic oil reserves, considering oil-savingmeasures and enhancing dialogue with oil-exporting countries

Wensheng et al (2014) examines the impact of structural oil price shocks on the

covariance of the US stock market return and stock market volatility by using theSVAR model in period from January 1973 to December 2013 The SVAR withrecursive structural restrictions follows up the order of variables such as: oil supply,aggregate demand, oil market-specific demand, and covariance of return andvolatility Positive shocks to aggregate demand and to oil-market specific demand

are associated with negative effects on the covariance of return and volatility Anunanticipated reduction in crude oil production is associated with a statisticallysignificant increase implied-covariance of return and volatility The spillover indexbetween the structural oil price shocks and covariance of stock return and volatility

is large and highly statistically significant

2.1.1.2 Positive effect from crude oil price to stock market

Zhu et al (2013) researches on structural dependence between crude oil prices and

Asia-Pacific stock market returns There are many different approaches, however,traditional approaches such as VAR or VECM require variables follow normal orStudent t-distributions Furthermore, it is well known that traditional mean varianceoptimization analysis portfolios are symmetric measures that cannot capture non-linear dependence or changes in the tails of asset return curves and that investorspay closer attention to downside than to upside risk The model proposed is thecopula - GARCH models The data set includes daily crude oil prices and ten Asia –Pacific countries' stock returns from January 4, 2000 to March 30, 2012 The data isdivided into two subsamples referred to as pre-crisis (January 4, 2000 to 23September 2008) and post-crisis (September 24, 2008 to March 30, 2012),respectively to explore differences of the dependence between phases The resultsshow that the dependence between crude oil prices and Asia-Pacific stock marketreturns is generally weak, that it was positive before the global financial crisis,except in Hong Kong, and that it increased significantly in the aftermath of thecrisis They found that the tail dependence was very weak before the crisis and thatthe lower tail dependence was much higher than the upper tail dependence after thecrisis, except in the cases of Japan and Singapore

Moya-Martínez et al (2013) examines oil price sensitivity of Spanish industries

for the period January 1993 to December 2010 Data set includes weeklyobservations of stock market returns (proxied by indices General de la Bolsa deMadrid), weekly returns of 14 industries, the Dated Brent crude oil prices and

interest rates A multifactor market model is used to investigate the impact of oilprice changes on industry stock returns and is estimated for sub-samples based onthe breakpoints identified by Bai and Perron multiple structural break tests Theresult indicates that the exposure of Spanish industries to oil price is rather limited,although the oil price exposure is different considerably between industries Theexposure was very small in the 1990s, period of fairly stable and cheap oil prices Itincreases in the 2000s with higher and more volatile oil prices Because aggregatedemand-side oil price shocks are driven by fluctuations in the global business cycle,

so crude oil price and Spanish equity market have moved together

Riza et al (2015), this study contributes to the literature on the relationship between

oil and stock markets by formally testing whether oil price risk is systematicallypriced in the cross-section of stock returns in net oil exporting nations, the GulfCooperation Council (GCC) nations Using firm-level data on Gulf Arab stockmarkets for the period March 31, 2004 and March 31, 2013 such as stock price,number of shares and book equity data, combine with exchange rate, three-monthU.S Treasury Bill rate as the risk-free rate, and Brent crude oil prices The resultsindicate that stocks that are more sensitive to oil price fluctuations indeed yieldsignificantly higher returns, suggesting that oil price risk exposure can serve as areturn predictor in these stock markets Interestingly however, there is no yieldevidence of a significant risk premium associated with oil price risk in the presence

of firm-level risk factors, suggesting that firm-level factors like firm size andidiosyncratic volatility controls for the oil price risk in returns, rendering the oilfactor insignificant in their test

Su-Fang et al (2011), investigate the relationship between oil prices and the

Chinese stock market at the sector level Using the a panel cointegration withstructural breaks and Granger causality framework and data collected from July

2001 to December 2010 including monthly real oil price, the real stock price indicesfor the 13 major sectors and a controlling variable, interest rate Their

findings show that there exist a positive relationship between oil prices and sectoralstock prices in the long run It may also indicate that the impact of other substituteenergy sources (e.g., coal) or other internal and domestic factors on these sectoralstocks are more dominant than the increase in oil prices The results of Grangecausality tests find a unidirectional, long-run and short-run relationship runningfrom oil prices and sectoral stocks to the interest rate for the period 2001/07–2005/10 Interesting however for period 2005/12–2007/06, there is only theunidirectional long –run Granger causality running from sectoral stocks to oil pricesand from sectoral stocks to the interest rate Additional, the long-run Grangercausality is bidirectional between oil prices, the interest rate and sectoral stocks for2007/08–2008/11 and 2009/01–2010/12.

2.1.1.3 Insignificant nexus between oil price and stock market

Apergis and Miller (2008) models the impact of oil market shocks to stock market

returns The components of oil market shock determined by modifying theprocedure of Kilian (2008a) include oil-supply shocks, global aggregate-demandshocks, and global oil-demand shocks The authors use the monthly data for theeight countries -Australia, Canada, France, Germany, Italy, Japan, the UnitedKingdom, and the United States – spans 1981 to 2007 and VAR model The resultsshow that different oil-market structural shocks play a significant role in explainingthe adjustments in stock-market returns But, the magnitude of such effects provessmall The oil-supply and global aggregate demand shocks do not significantlyexplain the stock return in Australia, whereas the idiosyncratic demand shocksaffect the stock return in Canada at a weaker level of significance Further, theGranger temporal causality tests suggest a strong role for idiosyncratic demandshocks leading the stock market returns, whereas the oil-supply and globalaggregate-demand shocks do not as a rule temporally lead the stock-market return

Janabi et al (2010) test for the efficient market hypothesis in the six Gulf

Cooperation Council (GCC) countries equity markets—namely Bahrain, Kuwait,

Qatar, Oman, Saudi Arabia, and the United Arab Emirates The dataset used in thisstudy consist of daily observations of the Standard & Poor's (S&P) EmergingMarket Indexes for six countries for the period April 03, 2006 through March 28,

2008 and two benchmark indexes for oil and gold Since the data is non-normal withtime-varying volatility, the authors apply a new methodology based on the leveragebootstrapped simulation technique The causality test results reveal that neither theoil price index nor the gold price index causes the equity price indexes of the sixGCC markets This means that the information contained in the gold and oil priceindexes cannot improve the forecast of the equity market index in each of the sixGCC states Thus, the possibility of short-term arbitrage is ruled out and the sixGCC equity markets can be considered as informationally efficient with respect tooil and gold prices

2.1.1.4 The imperial evidences about the relationship between oil prices and Vietnam stock market

Vo Xuan Vinh (2014) investigates the long and short-run relationship between

Vietnam’s stock prices (VN-Index) and the US stock prices (S&P 500 Index), the

US Dollar - VN Dong exchange rates, gold prices, and crude oil prices The paperuses the daily data from 01/04/2005 to 12/31/2012 and divides the entire sampleinto two sub-periods to account the effect of 2008 Global financial crisis, the firstone is 2005-2007 and the second one is 2008-2012 In the short term the paperindicates a high level of correlation between the VN-Index and the crude oil price.The evidences from the bivariate cointegration test show that there exist the long-run relationship between VN index and crude oil prices in the whole periods and thesecond sub-period In this sub period, there only exist the long run-relationshipbetween VN index and exchange rate The results of Grange causality tests find aunidirectional relationship running from oil prices to the stock market in the entireperiod and the first sub-period Additional, there is a unidirectional relationshiprunning from Exchange rate to the stock prices in the first sub-period

Narayan and Narayan (2010) model the impact of oil prices on stock prices in

Vietnam stock market The study uses the daily data for period from 2000-2008 ofstock prices, nominal exchange rates and oil prices Using the cointegration testsincluding Johansen test and structural break cointegration tests finds there exists thelong run relationship between stock market, oil prices and exchange rates Runningthe long-run elasticities, the authors find that oil prices and exchange rates have apositive and significant effect on stock prices However, the result is inconsistentwith the theoretical expectations Because they think that there are some differentfactors contributing to the stock market boom in this period such as increasingforeign portfolio investment capital flows and local market participants The studyalso combines the long –run model with the short-run model by using errorcorrection model The results show the determinants of stock prices are statisticallysignificant in the long run and they are insignificant in the short run

Nguyen and Ishaq (2012) study the dependence structures and/or tail dependence

between oil price changes and stock market indices The tail dependence helps todetermine whether the two variables move together in the same or oppositedirections This paper employs two relatively new methods, namely the Plots(Kendall or K plot and chi plot) based on nonparametric method and the copula,based on parametric method The daily data sets include WTI crude oil prices andstock prices from China and Vietnam The study period in Vietnam is from 2002 toAugust 2009 and in China is from 2000 to August 2009 The results show that there

is left tail dependence between international oil price changes and Vietnam’s stockmarket, meaning that if the international oil price decreases, Vietnam’s stock marketwill also decrease accordingly While there is no evidence showing that taildependence in the relationship of international oil price changes and China’s stockmarket

2.1.2 The relationship between stock market and exchange rate

The exchange rate is used as a controling variable in my study I investigate thenexus between exchange rate and stock market based on two approaches.

Firstly, in accordance with Krugman and Obstfeld, (1997, Chapt 16): Theconnection between the asset market equilibrium and the exchange rate is theinterest parity condition

= ∗ + ( − )/

where R and R* are interest rates of domestic and foreign currencies and E anddenote exchange rate and expected future exchange rate respectively For assetmarkets to remain in equilibrium, ceteris paribus, a decline in domestic output(hence lower R due to reduced demand for money) must be followed by a currencydepreciation (a greater value for E) Aggarwal (1981) has argued that a change inexchange rates could change stock prices of multinational firms directly and those

of the domestic firms indirectly In the case of a multinational firm, a change inexchange rate will change the value of that firm’s foreign operation, which will bereflected on its balance sheet as a profit or a loss Consequently it contributes tocurrent account imbalance Once the profit or a loss is announced, that firm’s stockprice will change This argument shows that devaluation could either raise or lower

a firm’s stock price depending on whether that firm is an exporting firm or it is aheavy user of imported inputs If it involves in both activities, its stock price couldmove in either direction This is true especially when most stock prices areaggregated to investigate the effects of devaluation on stock markets From thisviewpoint, exchange rate change is expected to give rise to stock price change Such

a causal relation is known as the traditional approach

Secondly, as capital market become more and more integrated, changes in stockprices and exchange rates may reflect more of capital movement than currentaccount imbalance The central point of such a portfolio approach lies in thefollowing logical deductions: A decrease in stock prices causes a reduction in the

wealth of domestic investors, which in turn leads to a lower demand for money withensuing lower interest rates The lower interest rates encourage capital outflowsceteris paribus, which in turn is the cause of currency depreciation Under theassumption of the portfolio approach, stock price is expected to lead exchange ratewith a negative correlation If a market is subject to the influences of bothapproaches simultaneously, a feedback loop will prevail with an arbitrary sign ofcorrelation between the two variables.

Bahmani et al (1997) are the pioneers of using cointegration and Granger causality

techniques to investigate the interaction between stock prices and FX markets Thedata they used consist of monthly S&P500 and effective exchange rates of US dollarfrom December 1973 to December 1983 A two-stage systematic autoregressiveprocedure was employed developed by Hsiao (1981) They found bidirectionalcausality in the short run However, there is no long-run relationship between thevariables

Nieh and Lee (2001), their major findings from their time-series estimations

supported the results of Bahmani-Oskooee and Sohrabian (1992) and reported nolong-run

Ajayi and Mougoue (1996) showed a negative short-run and positive long-run

impact of stock prices on domestic currency value Particular, in a study, recentadvances in time-series are applied to examine the intertemporal relation betweenstock indices and exchange rates for a sample of 8 advanced economies An errorcorrection model (ECM) of the 2 variables is employed to simultaneously estimatethe short-run and long-run dynamics of the variables The ECM results revealsignificant short-run and long-run feedback relations between the 2 financialmarkets Specifically, the results show that an increase in aggregate domestic stockprice has a negative short-run effect on domestic currency value In the long run,however, increases in stock prices have a positive effect on domestic currency

value On the other hand, currency depreciation has a negative short-run and run effect on the stock market

long-Roll (1992) also studied the US stock prices and exchange rates and found a

positive relationship between the two markets On the other hand, Chow et al.(1997) examined the same markets but found no relationship between stock returnsand real exchange rate returns They repeated the exercise with a longer timehorizons and found a positive relationship between the two variables

Abdalla and Murinde (1997) studied the prices in FX and stock markets in four

less developed countries, namely India, Korea, Pakistan, and Philippines within aVECM (vector error correction model) framework For the period January 1985 toJuly 1994, they find unidirectional causal linkage between exchange rates and stockprices for Pakistan and Korea The real effective exchange rate Granger cause thestock price index in India, but no causal relationship was found in the case ofPhilippines

Ajayi et al (1998) examine the interaction between daily stock returns and changes

in the exchange rates for two groups of markets: Advanced economies (includingCanada, Germany, France, Italy, Japan, UK, and USA) whose data start from April

1985 to August 1991 and Asian emerging markets (including Taiwan, Korea, thePhilippines, Malaysia, Singapore, Hong Kong, Indonesia, and Thailand) whose datacover December 1987 to September 1991 In the case of Indonesia, the Philippines,Taiwan, and all advanced markets, there is one-way causal relationship runningfrom the stock market to the FX market, while in the case of Korea, the relationship

is reverse They also perform causality test on weekly data and find that the resultsare in line with the daily data for the advanced markets However, a very differentresult is obtained for emerging markets: unidirectional causal relationship from thestock returns differential to the change in the exchange rate is found for Thailandand Malaysia

Granger et al (2000) apply Granger causality test and IRF to examine the

interaction between stock prices and FX market Nine Asian countries and regionsare selected for the empirical analysis: Hong Kong, Indonesia, Japan, South Korea,Malaysia, the Philippines, Singapore, Thailand, and Taiwan Their study employsdaily data from 3 January 1986 to 14 November 1997 (3097 observations) Threesub-periods are fractionized from the whole analyzed period: the first period startedfrom the first observation to 30 November 1986; the second period extends from 1December 1987 to the end of 1994 and it is called after crash period; and the thirdone covers the rest observations In the first period, by using 10% as significancelevel, there is no causal linkage for those countries except Hong Kong and SouthKorea, which have one-way causality from exchange rate to stock price and fromstock price to exchange rate, respectively In period 2, the authors findunidirectional causal linkage from FX markets to stock markets in Malaysia and thePhilippines and reverse linkage in Taiwan During the last period, it is found that thechange in stock prices will lead the change in the exchange rates in Taiwan, and thereverse relationship is found in Japan, Thailand, Singapore, and Hong Kong In therest markets, bidirectional causal relationships between the two variables wereestablished Moreover, the study shows that the predictable portion of stock pricechanges can be improved by including the exchange rate variation within theregression

2.2 Overview about Vietnam stock market, oil sector and exchange rate regime

2.2.1 Vietnam stock market

Vietnam is a MSCI frontier market likes Pakistan, Sri Lanka and Bangladesh.Frontier markets are investable but have lower market capitalization and liquiditythan the more developed emerging markets

Vietnam has two stock exchanges – the Ho Chi Minh Stock Exchange (HOSE) andthe Hanoi Stock Exchange (HNX) HOSE is mostly dedicated to equities trading,while HNX trades equities, bonds and over the counter securities.

HOSE was initially established as the Ho Chi Minh City Securities Trading Center(HoSTC) in 2000 It was later upgraded and renamed in 2007 Prior to March 1st

2002, shares were only traded on alternate days The Vietnam equities market hascome a long way in a short time In January 2006, there were only 34 companieslisted on HOSE; this has increased to 303 in 2012, with the market cap expandingfrom USD 1.1billion in 2006 to USD 29.9 billion in 2012 In 2015, there are 600-

700 companies listed on HOSE with the market capital of USD 60 billion

Figure 2.1 shows the market capitalization to GDP from 2004 to 2016 This ratiosignificantly increases over year-to-year In 2013-2014, the market capitalizationaccounted about 31% GDP and increased 24% compared to 2006 However,compared with other emerging markets such as China, India, and South Africa, thenVietnam stock market is relatively less developed

35.00

31.00 31.50 30.00

15.00

14.07

10.00

7.06 5.00

0.41 0.61

0.00

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Banking-insurance 19%

Food 32%

Real estate 4%

Contruction 6%

Electricity/ gas Energy

Figure 2.2 expresser the proportion of sectoral market capitalization in 2015 It

shows that oil industry has the fifth percentage of market capitalization about 6%

Therefore, the volatilities in world oil prices may have an immediate impact on the

market

2.2.2 Oil section

Over the past few decades Vietnam has emerged as an important oil and natural gas

producer in Southeast Asia Vietnam has boosted exploration activities, allowed for

greater foreign company investment and cooperation in the oil and gas sectors, and

introduced market reforms to support the energy industry These measures have

helped to increase oil and gas production Also, the country’s rapid economic

growth, industrialization, and export market expansion have spurred domestic

energy consumption

Recent, successful offshore exploration has contributed to a substantial increase in

proved crude oil reserves, which grew to 4.4 billion barrels as of January 2012 from

increase this figure in the future, as Vietnam’s waters remain largely underexplored.Vietnam is currently the third-largest holder of crude oil reserves in Asia, behindChina and India.

Vietnam, the Philippines, Malaysia, China, Taiwan, and Brunei each claimsovereignty over the Spratly Islands in the South China Sea However, Vietnam hasreached agreements with several of its neighbors to conduct joint exploration for oiland natural gas resources in the region Disputes with China are yet to be resolved

As recently as May 7th, 2014, tensions between China and Vietnam flared following

a skirmish over a Chinese oil rig that Vietnam claims was planning to illegally drillinto the Vietnam's continental shelf In addition, on September 15, 2014, Vietnamand India agreed to expand joint upstream oil and gas activities in the contestedwaters of the South China Sea, despite China's objections

According to Ministry of Industry and Trade, in September 2015, the nationwidecrude oil production is estimated at about 13.9 million tons, increase 9% comparedwith the same period of 2014

By the way, gas production is estimated at 7.8 billion m3, increase 1.8% comparedwith the same period of 2014 Petroleum production is estimated 5.1 million tons,increase 25.7% compared with the same period of 2014

Vietnam produced around 353,700 barrels per day (bbl/d) of oil in 2013, which isroughly 3% less than what it produced in 2012 and 12% down from a peak of403,000 bbl/d in 2004 The Cuu Long Basin has been the primary area for oilproduction

Vietnam is a net exporter of crude oil, but is a net importer of oil products With oilconsumption increasing year-over-year and overall by more than 70% from 238,400bbl/d in 2004 to 413,000 bbl/d in 2013, the country must import a majority ofrefined products to satisfy demand

Vietnam has one operating refinery, the 140,000-bbl/d Dung Quat refinery, whichcame online in 2009 Vietnam's state-owned Vietnam Oil & Gas Corporation(PetroVietnam) is looking to boost crude distillation capacity to around 200,000 bbl/

d by 2017 and to develop Dung Quat's ability to handle sweet and less expensivesour crude oil from Russia, the Middle East, and Venezuela Vietnam plans to offer49% of Dung Quat's equity to foreign investors in order to finance the upgrade andexpansion of Dung Quat In addition, the Nghi Son refinery, which is now underconstruction, is expected to come online in mid-2017 and the Vung Ro refinery,which will be designed by Japan's JGC Corporation, is expected to be completed in2019

PetroVietnam is the key company in the oil and natural gas sectors and serves as theprimary operator and regulator of the industry Oil and natural gas production iseither undertaken by PetroVietnam's upstream subsidiary, PetroVietnamExploration and Production (PVEP), or through PetroVietnam's joint venture withother companies

International Oil Companies (IOCs) such as ExxonMobil, Chevron, andZarubezhneft have formed partnerships with PetroVietnam IOCs must receiveapproval from the Oil and Gas Department of the Prime Minister and mustnegotiate upstream licenses with PVEP

Average oil price in September 2015 is about 48 USD/ barrel, total exploitingproduction of PVN by the end of September is estimated at about 21.86 milliontons In this period, the group exports 11.9 million tons of crude oil but the revenueonly reaches 3.05 billion dollars compared to September 2014 exporting 6.8 milliontons, reaching 5.98 billion dollars The crude oil price has decreased leading theexporting volume increases but the exporting revenue still decrease

Vietnam currently holds 24.7 trillion cubic feet (Tcf) of proved natural gas reserves,

up from 6.8 Tcf in 2011, according to OGJ Increased foreign investment since

2007 has led to greater exploration, significantly increasing Vietnam's provednatural gas reserves.

Vietnam produced 346 billion cubic feet of marketed natural gas in 2013, all of

which was domestically consumed, according to the BP Statistical Review of World

Energy 2014 The country is currently self-sufficient in natural gas, but

PetroVietnam predicts a growing supply gap characterized by demand surpassingsupply, particularly in southern Vietnam Vietnam's 2011 Gas Master Plan includesinitiatives to promote natural gas in the primary energy mix, gas production andconsumption targets, and detailed infrastructure plans for gas gathering systems,pipelines, and gas processing facilities

The Vietnamese government has considered importing liquefied natural gas (LNG)

in the southern part of the country to meet growing natural gas demand and fill thesupply gap PetroVietnam Gas, a subsidiary of PetroVietnam, signed amemorandum of understanding and a front-end engineering and developmentcontract with the Tokyo Gas Company to develop the Thi Vai LNG terminal in theVung Tau province The terminal is expected to be operational in 2017 PV Gas alsosigned a gas sales and purchase agreement with Gazprom of Russia on March 6,

2014 Under the agreement, PV Gas will receive 48 Bcf/y via the Thi Vai LNGterminal A second terminal, Son My LNG, is also planned for operations starting in

2018, although construction has yet to begin

2.2.3 Exchange regime

In Vietnam, exchange rate policy can be seen as a part of monetary policy to affect

to supply and demand of foreign currency on exchange market and archive thetargets of monetary policy is to control inflation and stabilize the purchasing power

of money, encourage exports, restrict imports and enhance the economic growth

Vietnam officially applies the pegged exchange rates with crawling bands in March

1989 According to this exchange regime, the exchange rates of commercial banks

were followed to fluctuate within the limits of 5% of official exchange rate In theperiod from 1990-1991, commercial banks were followed to determine exchangerates not exceeding 0.5% of official exchange rates.

Figure 2.3 Average interbank exchange rates from 2006 to 2015

After Vietnam took part in World Trade Organization in 2007, the foreigninvestment capital flows into the economy sharply increased in 2007-2008 This ledthe foreign currency supply exceed demand in the large scale, so the exchange rates

of commercial banks were always at the lower bound of allowed amplitude.However, the impacts from financial crisis led the foreign investment capital flowsinto Vietnam in the second haft of 2008 reverse In addition, the pressure ofinflation, increasing trade deficit, large difference between domestic and foreign oilprice had the exchange rates of commercial be in the upper bound of allowedamplitude in 2009 State Bank of Vietnam (SBV) had to constantly increase theofficial exchange rate and loosen the trade band Especially, on 26/11/2009 SBVwas forced to officially adjust 5.4% of basic exchange rate, the highest rate per dayfor 10 years

In the period from 2012 – 2014, the exchange rates were quiet stable and fluctuate

in the allowed rate band Inter-bank average exchange rate was fixed at 20,282VND/USD over the long time before being slightly adjusted to 21,036 VND/USDsince the end of June, 2013 The trade band was fixed at 1% since the beginning ofFebruary 2011

However, China strongly devaluates their Renminbi currency and the marketinvestors are being worry about the US Federal Reserve System (Fed) is going toadjust interest rates In order to actively lead the market and deal with the adverseimpacts of possibility of increase of interest rate from Fed, SBV adjusts the averageinterbank exchange rate from 21,673 VND/USD to 21,890 VND/ USD applied fromAugust, 18th 2015 Also, SBV simultaneously issues the 1636/ QD-NHNN decisionabout VND spot rates of commercial banks, according to it, the band of VND/USD

is adjusted from ±2% to ± 3%

3 Data and research methodology

Daily dataset consisting of Brent crude oil price, average interbank exchange rateand Vietnam stock market index proxied by VN index is chosen in periods from01/03/2006 to 08/31/2015 Although Vietnam stock market officially started in

2000, during 2000-2005 the market size only reached 1% GDP and the marketactivities was fairly quiet From 2006, the stock market had significantly chancesabout both number of listed companies and trade volume Specifically, the marketsize had a huge leap to 22.7% GDP and moreover, capital mobilization such IPO,issuing bond, indeed only incurred from 2006 onward Therefore the beginning year

of study period is 2006 to ensure the stock market be able to reflect the economicsituation

Many important events has incurred during the study period such as 2007 financialcrisis, USA shale oil revolution have enormous impacts on economy, stock market,oil prices, To have a better insight, we divide the study period into 04 phasesattached to 02 main events, those are 2007 financial crisis and USA shale oilrevolution in 2014 (See the figure 3.5)

The first phase from 01/03/2006 to 12/28/2007 is called pre-crisis phase (seefigure3.1): in this phase, the Vietnam stock market was the most flourish andvibrant In the end of 2006, VN-index increased by 2.5 compared to in thebeginning of year, led to the market capitalization reaching USD 13.8 billionaccounted about 22.7% GDP The number of the listed companies was up about 5times, VN-index rise further 500 points from 300 points in the late 2005 to 800 inthe late 2006 Securities law in effect from January 01st, 2015 has contributed inpromoting the development and integration of the stock market The transparency ofthe listed companies has been strengthened After that VN-index peaked at 1,170.67and increased by 23.3% compared to the late 2006 It can be said that the

market reached the biggest growth rate in this stage, especially; this rate is 126%just within the first quarter In HCM Exchange, the average of trade volume wasmore than VND 1,000 billion/ session and it was VND 300 million at HNX.

Figure 3.1 Graphical presentation of the series for first phase

The second phase from 01/02/2008 to 12/31/2009 (see the figure3.2) is called crisisphase: Along to the general trend of economy, Vietnam stock market in 2008sharply declined It was impacted directly by macro-economic instability such as theinflation increase, large trade deficit that forced the government to make a tightmonetary policy and squeeze the cash flows into securities Additionally, the

influence of global financial crisis had the VN-index bottomed at 235.5 points as of 02/24/2009.

Figure 3.2 Graphical presentation of the series for the second phase.

The third phase from 01/04/2010 to 06/30/2014 is called after crisis phase (see thefigure 3.3): The stock market also snappily changes but it was following to apositive trend in 2010-2012 From the beginning of 2013, the market shaped a quietcertain recovery trend As of the end of 2013, VN-index reached 505 points, up23% Vietnam stock market was considered as one of the 10 markets with thestrongest recovery growth and degree compared to the world This is the period thatthe crude oil price remained at the stable levels more than $100/ barrel

Figure 3.3 Graphical representation of the third phase.

The last phase from 07/01/2014 to 08/31/2015 (see the firgure3.4) is called USAshale oil revolution phase: Crude oil prices fell sharply in the fourth quarter of 2014

as robust global production exceeded demand After reaching monthly peaks of

$112 per barrel and $105 per barrel in June, crude oil benchmarks Brent fell to lessthan $50/ barrel in August In additional, on the August, 18th 2015, State bank SBVadjusts the average interbank exchange rate from 21,673 VND/USD to 21,890 inorder to actively lead the market and deal with the adverse impacts of possibility ofincrease of interest rate from Fed Two events significantly impact to Vietnameconomy

Figure3.4 Graphical representation of the fourth phase.

Figure 3.5 Graphical representation of the entire sample.

Table 3.1 Variable descriptions and sources:

Stock price Vietnam stock market Lvni Ho Chi Minh City stock

logarithm

Oil price Brent crude oil price Loil Website of Energy

Exchange Inter-bank average Lex Website of the State Bank of

logarithm

3.2 Methodology

3.2.1 Gregory and Hansen Test - GH test

GH test was developed by Gregory and Hansen (1996), this is a residual-based test

of cointegration with null hypothesis is no cointegration and alternative hypothesisthat there may be one break in the cointegrating vector The test is an extension ofthe ADF, Zt, and Za test for cointegration and is non-informative with respect to thetiming of the break To test break points in cointegration vector, the authors usedthree alternative models: (i) level shift (only intercept can change), (ii) level shiftwith trend (only slope coefficients can change) and (iii) regime shift (both interceptand slope coefficients can change)

In this study, I use the third model “regime shift” The dependent variable is lvniand independent variables are lex and loil The standard model of cointegration with

a trend and no structural change is: