CO-MOVEMENT OF OIL PRICE, EXCHANGE

RATE AND STOCK INDEX OF MAJOR OIL

IMPORTING COUNTRIES: A WAVELET
COHERENCE APPROACH
M.Thenmozhi*
Indian Institute of Technology Madras, India
N. Srinivasan*
Indian Institute of Technology Madras, India

ABSTRACT
The study examines the co-movement between oil price and macroeconomic indicators such as
exchange rate and stock indices of major oil importing countries. We differ from previous studies
by examining the co-movement using wavelet coherence analysis and examine the macroeconomic
dynamics of major oil-importing countries during all the economic cycles across different
frequencies. We use nominal price rather than real price to make the results more meaningful for
traders and institutional investors. Our analysis is based on 3012 observations covering the period
2003-14for fifteen major oil importing countries. Wavelet Coherence analysis indicates a high
coherence between oil price and macroeconomic indicators across all the countries during the
financial crisis. The nominal exchange rates tend to have negative relationship with benchmark oil
prices except exchange rate of Japan in the long run and exchange rate of South Korea in the
medium run. Stock indices tend to have positive relationship with benchmark oil prices in both long
and medium run. S&P is leading the oil price, whereas SSE50, Nikkei 225, NIFTY, KOPSI, DAX,
CAC, IBEX, FTSSI, FTSEMIB, AEX, TWSE, XU 100, LQ45 and BEL 20 are lagging the oil price
in the long run. In the medium term, except for NIFTY, oil price is leading the stock market index.
Overall, the results indicate that the oil price and stock indices of the major oil-importing countries
are correlated in long and medium term, but not in short term. The leadlag relationship between
oil price and macroeconomic indicators are observed to change across frequency and time. While
exchange rate offers diversification benefits, stock market indices provide no diversification
avenues since the pattern of co-movement of stock market indices and oil prices are similar across
all oil importing countries. The results have implications for individual traders and institutional
investors while designing their portfolio for short, medium and long term time horizons.
JEL Classifications: G14, G15
Keywords: Crude oil, Stock market, Exchange rate, Co-movement, Continuous wavelet transform.
Corresponding Authors Email Address: mtm@iitm.ac.in; sin.iitm@gmail.com.

INTRODUCTION

Crude oil is actively included in the portfolio of various hedge funds and variability in oil
price has significant linkage with various macroeconomic indicators of a country. Oil
price has influence on a countrys economy and thus on inflation and interest rate. Oil
prices affect the stock prices either directly by influencing future cash flows of a
company or indirectly by affecting the interest rate that is used to discount the future cash
flows of a company. Change in stock prices and exchange rates also impacts oil prices.
But, the nature and extent of relationship between oil price and macroeconomic
indicators may vary from time to time and understanding the pattern of relationship
across time and frequency horizon becomes essential for traders and investors.
LITERATURE REVIEW
Previous studies that examined the relationship between the crude oil and exchange
rates/stock indices indicate inconsistency in results. Long-run equilibrium exists between
the crude oil price and exchange rate (Amano and Van Norden, 1998; Chaudhuri and
Daniel, 1998; Chen and Chen, 2007; Oriavwote and Eriemo, 2012). Some argued that
increase in oil prices is associated with the appreciating exchange rate (Amano and Van
Norden, 1998; Benassy-Quere et al., 2007; Narayan et al., 2008; Basher et al., 2012;
Beckmann and Czudaj, 2013). But other studies argued that increase in oil prices is
associated with the depreciating exchange rate (Wang and Wu, 2012). While bidirectional causality exists between oil price and exchange rates after crisis (Ding & Vo,
2012), at large time horizons (Benhmad, 2012) and at higher time scales (Tiwari et al.,
2013), Iwayemi and Fowowe (2011) find no impact of oil price on exchange rates.
Few studies (Cong et al., 2008; Park and Ratti, 2008) found that, oil price
shocks have no impact on the real stock returns and during crisis oil shocks do not affect
stock market phases (Jammazi and Aloui, 2010). However, Miller and Ratti (2009) and
Jammazi (2012) found that stock market reacts negatively to increase in oil price in the
long-run. There is also evidence that increase in emerging market stock prices increases
oil prices (Basher et al., 2012),but the impact of oil price shocks on stock prices for
emerging countries is mixed partly in contrast to developed stock markets. Moreover, the
stock returns of large oil producing and consuming countries have relatively strong
dependence with oil price (Sukcharoen et al., 2014) and the dependence between
commodity and stock market is time varying and symmetrical (Delatte and Lopez, 2013).
Traders and institutional investors have varied investment horizons and different
risk profiles and co-movement between oil prices and macroeconomic indicators
becomes important to assess the risk profile of countries and the market movements.
While traders would prefer analysis based on nominal prices, most of the studies have
focused on real prices.
Most of the existing literature examines the co-movement using traditional time
series models such as OLS, VAR/ VECM, co-integration and detrended correlation
analysis, which look into the time scale of the variables. However, co-movement between
variables may vary across time and the effect could change at different time horizons.
Very few studies have used wavelet analysis to capture the co-movement dynamics across
time and frequency scales (Rua and Nunes, 2009; Tiwari et al., 2013;Loh,
2013).Moreover, existing studies have examined the relationship between oil prices and
exchange rates/ stock indices for one country/ few countries, which are mostly developed

markets. But, very few studies focus on the relationship between the oil prices and
emerging stock markets (Basher and Sadorsky, 2006; Hammoudeh and Huimin, 2005)
and have used the same crude oil benchmark irrespective of the type of crude oil
consumed in the country. Besides, prior studies have not focused on oil importing
countries or analyzed from traders perspective considering nominal prices.
Hence, this study focuses on traders and institutional investors perspective and
examines the co-movement between benchmark oil price with (i) nominal exchange rates
and (ii) stock indices of major oil-importing countries using wavelet coherence approach.
Our study contributes to the literature in three ways:
I.

First, previous literature extensively focuses on time series methodologies to

measure co-movement, while we study the relationship between the crude oil
and macroeconomic indicators both at time and frequency domain.

II.

Second, different crude oil benchmarks such as WTI, Brent and OPEC have
been used. The OPEC basket crude is used for Asian countries; Brent oil price is
used for Europe and WTI oil price is used for the US.

III.

Third, existing literature focused more on real prices (Tiwari et al., 2013;
Benhmad, 2012). We use nominal prices of oil instead of real prices, and thereby
enable investors to shift their positions quickly in stock and forex market to
mitigate the risk arising from volatility in oil prices.

The remainder of this paper is organized as follows: the next section discusses
the data and methodology. The empirical results of wavelet analysis are explained in the
subsequent section and concluded with major findings and implications of the study.
DATA AND METHODOLOGY
Methodology
The study used continuous wavelet transform to examine the co-movement of oil price
with (i) nominal exchange rates and (ii) stock indices of major oil-importing countries. A
wavelet transform provides a three-dimensional diagram that illustrates time series
information at different frequencies, time and strength. The frequency could range from
low to high; the time could range from short term to long term and finally, the strength of
association is measured by color coding. In this study, we follow Grinsted et al. (2004)
framework of WTC. Initially, we use CWT to remove noise in the series and then we use
WTC to set the pattern of co-movement.
Continuous Wavelet Transform (CWT)
A wavelet is a function with zero mean and that is localized in both frequency and time.
CWT is used to remove the noise in the series. The CWT of a time series (

x n , n = 1,

, N) with uniform time steps

t , is the convolution of

x n with the scaled and

normalized wavelet, is defined as

w xn ( s )=

t
t
x n 0 (n' n)
.

s n =1
s
'

'

(1)

w xn (s )2
We define the wavelet power as
. The complex argument of

w xn (s ) can be interpreted as the local phase. Since the wavelets are not completely
localized in time, CWT has edge effect which is addressedby introducing Cone of
Influence (COI), which eliminates edge effects. The statistical significance of wavelet
power is assessed relative to the null hypotheses that the signal is generated by a
stationary process with a given background power spectrum (

pk ).We follow the

procedure used by Torrence and Compo (1998) for data generation using Monte-Carlo
simulation process and the corresponding distribution for the local wavelet power
spectrum at each time n and scale

s as follows:

wnx ( s)2
<p
2x

(2)

Wavelet Coherence (WTC)

WTC is used as a tool to find the relationships between two series. The relationship is
found through the frequency bands and time intervals. The wavelet coherence is seen as a
localized correlation coefficient in the time frequency space. Wavelet coherence of the
change in the oil price and macroeconomic indicators differential series is defined as:

S ( s1 wnx ( s )2) . S (s1 wny ( s )2 ).

S (s1 wnxy ( s ) ) 2

2
R n ( s )=
(3)
We follow Wavelet Coherence as defined by Torrence and Webster (1999),
2

Rn ( s ) is the value of Wavelet squared

where S is a smoothing operator and

coherency. The numerator and the denominator explain the squared absolute value of the
smoothed cross-wavelet spectrum and the smoothed wavelet power spectra, respectively.
Data
This study uses daily time series data of various benchmark crude oil prices such as the
WTI, Brent and OPEC basket crude oil spot price . The OPEC basket crude is used for
Asian countries; Brent oil price is used for Europe and WTI oil price is used for the US.
We identify top fifteen oil importing countries based on the EIA crude oil import
statistics1. The data comprises stock indices of oil-importing countries such as the US
(SPX), China (SSE50), Japan (NKY), India (NIFTY), South Korea (KOSPI), Germany
(DAX), France (CAC), Spain (IBEX), Singapore (FSSTI), Italy (FTSE MIB),
Netherlands (AEX), Taiwan (TWSE), Turkey (XU100), Indonesia (LQ45) and Belgium
(BEL20) and the exchange rates of oil-importing countries such as China (USDCNY),
Japan (USDJPY), India (USDINR), South Korea (USDKRW), Germany (USDEUR),
France (USDEUR), Spain (USDEUR), Singapore (USDSGD), Italy (USDEUR),
Netherlands (USDEUR), Taiwan (USDTWD), Turkey (USDTRY), Indonesia (USDIDR)
and Belgium (USDEUR) are used for the study. Daily data for the period starting from 6 th
January 2003 to 30th December 2014 (3012 observations) has been considered, except for
the Stock index of China (SSE50) which starts from 5 th January 2004 to 30th December
2014 (2765 observations). The data is collected from Bloomberg database and all the
series have been converted into log returns.
EMPIRICAL RESULTS
Co-movement Analysis based on Wavelet Coherence
WTC is used to measure coherence and phase lag between two time series in both time
and frequency (Chang and Glover, 2010). Figures 1.11.9 and 2.12.15 present the
Wavelet coherence plot2. Monte-Carlo simulations are used to estimate the 5%
significance level. The figure follows a color code for coherency ranges from blue (which
is close to0) to red (which is close to 1), where blue refers to low coherency and red
refers to high coherency.

In the Wavelet coherence plot, the horizontal axis represents time and the
vertical axis shows time scales in days as frequencies. Time scale 1 denotes 24 days;
Time scale 2 denotes 48 days, Time scale 3 denotes 816 days and so on. The time
scales are described as high, medium and low frequency, where high represents short-run
dynamics, medium represents medium-run and low represents long-run dynamics of the
two series.In the phase, i.e., arrows pointing to the right, denotes that variables have
positive effect, i.e., increase in oil prices increases the exchange rate/stock index. Out of
the phase, i.e., Arrows pointing to the left, denotes that variable has negative effect, i.e.,
an increase in oil prices decreases exchange rate/ stock index. The direction of the arrows
(up/down) determines whether its leading or lagging the other series. Right and up
denotes series is lagging; right and down denotes series is leading. Likewise, left and up
denotes the series is leading; Left and down denotes that series is lagging.
Relationship between Benchmark Oil Prices and Exchange Rates
The association between the USDEUR and oil price (Figure 1.1) is found to be high in
both medium and short term. It is also observed from the graph that during the crisis
period the coherency is high and USDEUR is leading the oil price in medium term,
whereas in long term, USDEUR is lagging the oil price. Anti-cyclical effect is observed
in all the three frequencies.
The correlation between the USDCNY and oil price is found to be low (Figure
1.2). Only during the second half of 2008, a high coherency is observed and during the
same period, USDCNY is leading the oil price.
A significant negative relationship between the USDIDR and oil price is found
(Figure 1.3) during crisis in both medium and long term. High coherency is witnessed
during the crisis period, and USDIDR is leading the oil price in the long term. Anticyclical effect is observed in both medium and long term.
Figure 1.4 shows a high coherency between the USDINR and oil price during
crisis in both medium and long term. During the crisis period, USDINR is lagging the oil
price in the long term, whereas in the medium term USDINR is leading the oil price.
The correlation between the USDJPY and oil price is found to be high (Figure
1.5) in the long term. A high coherency and cyclical effect is observed during crisis and
during the same period USDJPY is leading the oil price.
The correlation between the USDKRW and oil price is found to be high during
all times (Figure 1.6). It is also observed that, during crisis, USDKRW is lagging the oil
price in the long term, whereas it is leading the oil price in medium term. Anti-cyclical
effect is observed in the long term.
A high coherency between the USDSGD and oil price is witnessed during crisis
in the long term (Figure 1.7). During the crisis period, USDSGD is leading the oil price
in the medium and long term. Anti-cyclical effect is observed during the crisis.
The association between the USDTRY and oil price (Figure 1.8) is found to be
high during crisis in both in medium and long term. It is also observed from the graph
that, during the crisis period, USDTRY is leading the oil price in the medium and long
term.
The correlation between the USDTWD and oil price is (Figure 1.9) found to be
high in all frequencies. The short-term correlation is high during 2010. The correlation in
medium term is high during 2005, 2007 and 2009. In long term, high correlation is found

from 2007 to 2010. Anti-Cyclical effect is observed in the long term and USDTWD is
lagging the oil price in long term.
FIGURE 1: BENCHMARK OIL PRICES AND EXCHANGE RATES (WTC)
FIGURES
FIGURE 1.1: BRENT OILVs. USDEUR FIGURE 1.2: OPEC OIL Vs. USDCNY

FIGURE 1.3: OPEC OIL Vs. USDIDR FIGURE 1.4: OPEC OIL Vs. USDINR

FIGURE1.5: OPEC OILVs. USDJPY

FIGURE 1.6: OPEC OIL Vs. USDKRW

FIGURE1.7: OPEC OILVs. USDSGD

FIGURE 1.8: OPEC OIL Vs. USDTRY

FIGURE1.9: OPEC OILVs. USDTWD

Note: Figure 1 presents the wavelet coherency plot between oil price and Exchange rate. Waveletsquared coherencies are indicated by contour, the 5% significance level is denoted by a dashed
black line contour and the area outside this line is the boundary affected zone. The area affected by
edge effects are denoted by the cone of influence and the area outside the cone of influence has no

statistical significance. The color code for coherency ranges from blue (close to zero) to red (close
to one), where blue refers to low coherency and red refers to high coherency.

During financial crisis period, oil price is highly correlated with all the
exchange rates. The Chinese and Singapore exchange rates have minimal coherency with
oil price in all frequencies except during crisis. South Korea and Taiwan exchange rates
are highly correlated with oil price at all times. A portfolio of smaller horizon with oil as
an asset can lead to better diversification by adding USDCNY, USDIDR, USDINR,
USDJPY, USDSGD and USDTRY, whereas a medium-term portfolio can add USDCNY,
USDJPY and USDSGD to ensure diversification. In the long term, adding USDCNY,
USDEUR and USDSGD to the portfolio offers diversification benefits.
Relationship between Benchmark Oil Prices and Stock Indices
High positive correlation exists between S&P 500 and oil price (Figure 2.1) during crisis
in all frequencies. During this period, S&P 500 is leading the oil price. Cyclicality is also
witnessed during crisis. The correlation between the SSE 50 and oil price (Figure 2.2) is
found to be high in long and medium term. In the long term SSE 50 is lagging the oil
price. High correlation between the Nikkei 225 and oil price is found during 2007-2010
(Figure 2.3) in long term. The correlation in medium term was high during 2008 and
Nikkei 225 is lagging the oil price and positive cyclical effect is observed in the long
term.
The correlation between NIFTY and oil price (Figure 2.4) is found to be high at
all frequencies. The correlation in medium term is high during 2007-09. In the long term,
high correlation is observed from 2005 to 2012. In the long term, NIFTY is lagging the
oil price, whereas in the medium term it is leading oil price.
High coherency between KOSPI and oil price (Figure 2.5) is witnessed at all
frequencies. The high correlation in the long term is observed from 2006-2012 and
KOSPI is lagging the oil price. Positive cyclical effect is observed during the crisis.
The correlation between the DAX 30 and oil price (Figure 2.6) is found to be
high at all times. The correlation in short term is high during 2009. The correlation in
medium term is high during 20072008. In the long term, high correlation is observed
from 2007 to 2010 and DAX is lagging oil price.
A high correlation is observed between oil price and CAC in medium term
(Figure 2.7). In the long term, high co-movement is observed during 20072010. It is
observed that during this period the CAC is lagging the oil price.
The correlation between the IBEX and oil price (Figure 2.8) is found to be high
in the long term, particularly, during 2006 to 2012. In the long term, the IBEX is lagging
the oil price and a positive cyclical effect is observed.
High coherency between the FSSTI and oil (Figure 2.9) is witnessed at all
frequencies. The high correlation in long term is observed from 2006-2012. In the
medium term, high coherency is observed during 2005, 2008 and 2012. In the long term,
the FSSTI is lagging oil price and appositive cyclical effect is also observed.
The correlation between the FTSEMIB and oil price (Figure 2.10) is found to be
high in the long run. The correlation in medium term is high during 2008. In the long
term, high correlation is observed from 2006 to 2012 and FTSEMIB is lagging oil price.
A positive cyclical effect is also observed during the crisis.

10

The correlation between the AEX and oil price (Figure 2.11) is found in both
long and medium term. The correlation in medium term is high during 2009 and 2010. In
the long term, high correlation is observed from 2006 to 2012 and AEX is lagging oil
price. A positive cyclical effect is observed from the graph.
A high coherency is witnessed between the TWSE and oil price (Figure 2.12) in
the long term, particularly from 2006 to 2012. During this period, the TWSE is lagging
oil price in the long term.
The correlation between the XU 100 and oil price (Figure 2.13) is found to be
high in the long term, particularly during the period 2006 to 2011. In the long term, XU
100 is lagging the oil price.
High coherency between the LQ 45 and oil price (Figure 2.14) is found in both
long and medium term. The correlation in medium term is high during crisis 20072008.
In the long term, high correlation is observed from 2006 to 2010 and LQ 45 is lagging oil
price.
High coherency is witnessed between the BEL 20 and oil price (Figure 2.15) in
short, medium and long term. The high correlation in the long term is observed from
20062011 and BEL20 is lagging oil price. A positive cyclical effect is also observed.
FIGURE 2: BENCHMARK OIL PRICES AND STOCK INDICES (WTC)
FIGURES
FIGURE 2.1: WTI OILVs. SPX

FIGURE 2.2: OPEC OIL Vs. SSE50

11

FIGURE 2.3: OPEC OIL Vs. NKY

FIGURE 2.4: OPEC OIL Vs. NIFTY

FIGURE 2.5: OPEC OIL Vs. KOSPI

FIGURE 2.6: BRENT OIL Vs. DAX

12

FIGURE 2.7: BRENT OIL Vs. CAC

FIGURE 2.8: BRENT OIL Vs. IBEX

FIGURE 2.9: OPEC OILVs. FSSTI

13

FIGURE 2.10: BRENT OIL VS.

FTSEMIB

FIGURE 2.11: BRENT OIL Vs. AEX

FIGURE 2.12: OPEC OIL Vs. TWSE

FIGURE 2.13: OPEC OILVs. XU100

FIGURE 2.14: OPEC OIL Vs. LQ45

14

FIGURE 2.15: BRENT OILVs. BEL20

Note: Figure 2 exhibits the wavelet coherency plot for different benchmark crude oil price and
stock indices of oil importing countries. Monte Carlo simulations are used to obtain values for the
significance. Wavelet-squared coherencies are indicated by contour, the 5% significance level is
denoted by a dashed black line contour and the area outside this line is the boundary affected zone.

15

The area affected by edge effects are denoted by the cone of influence and the area outside the cone
of influence has no statistical significance. The color code for coherency ranges from blue (close to
zero) to red (close to one), where blue refers to low coherency and red refers to high coherency.

Overall, we find that, during financial crisis period, oil price is highly correlated
with all the stock indices. S&P 500, NIFTY, KOSPI, DAX, CAC, FSSTI and BEL have
high coherency with the oil price in all short, medium and long terms. A portfolio
ofsmaller horizon with oil as an asset can have better diversification by adding SSE 50,
Nikkei, IBEX, FTSEMIB, AEX, TWSE, XU100, LQ45 indices.Whereas a medium term
portfolio can add IBEX, FTSEMIB, TWSE, XU100 to ensure diversification. The
Japanese index Nikkei offers diversification benefits for a long-term portfolio. The
relationship of the oil prices with the stock indices and exchange rates is summarized in
Table 1.
TABLE 1: RELATIONSHIP DURING FINANCIAL CRISIS
Oil price Vs. Stock indices
Time /
Frequency
Scale

Short
Run/
High

Medium
Run/
Medium

Oil price Vs. Exchange rates

Long
Run/
Low

Time /
Frequency
Scale

Short
Run/
High

Medium
Run/
Medium

NKY
(+) Lag
(+) Lead
USDCNY
(-)
NIFTY
(+) Lead
(+) Lag
USDEUR
(-) Lead
LQ45
(+) Lag
(+) Lag
USDIDR Weak or
(-) Lead
KOSPI
(+) Lag
(+) Lag
USDINR
(-) Lag
Weak or
IBEX
(+) Lag
(+) Lag
USDJPY
(+)Lead
FTSEMIB
(+) Lag
(+) Lag
USDKRW NO
(+)Lead
FSSTI NO
(+) Lag
(+) Lag
USDSGD
(-) Lead
DAX
(+) Lag
(+) Lag
USDTRY Visible
(-)Lag
CAC Visible
(+) Lag
(+) Lag
USDTWD
(-)Lead
BEL20
(+) Lag
(+) Lag
Relationship
AEX Relationship
(+) Lag
(+) Lag
SPX
(+) Lag
(+) Lag
SSE50
(+) Lag
(+) Lag
TWSE
(+) Lag
(+) Lag
XU100
(+) Lead
(+) Lag
Source: Interpreted from Wavelet Coherence Figures 1.1 to 1.9 and 2.1 to 2.15.
Notes: Discontinuity in relationship is prevalent in medium and high frequencies across all time
period.

CONCLUSION
The study contributes to the literature by analyzing the co-movement between the
nominal oil price and macroeconomic indicators using wavelet coherence analysis and
highlights the pattern of relationship during crisis periods. The wavelet analysis shows:
(i) discontinuity in the co-movement at both time and frequency scales; (ii) weak or no
relationship in the short run, i.e., at high frequency, and visible relationship is found in

16

Long Run/
Low

(-) Lead
(-) Lag
(-) Lead
(-) Lag
(+)
(-)Lag
(-)
(-) Lead
(-)Lag

medium and long run, and (iii) the lead-lag relationship changes across frequencies and
time.
High coherency between the oil price and macroeconomic indicators is
witnessed across all the countries during financial crisis. The nominal exchange rates
have negative relationship with the benchmark oil prices except with exchange rate of
Japan in the long run and with exchange rate of South Korea in the medium run. The
stock indices have positive relationship in both long and medium run. The study explored
the portfolio diversification opportunities for traders and international investors investing
in oil derivatives. In the forex market, exchange rate of Japan acts as a hedge and also
offers diversification benefits against all the other exchange rates in the long and medium
run. The exchange rate of South Korea offers similar opportunities in the medium run.
The response of stock indices to the oil price movements has been highly similar, and
hence there are little or no possible diversification benefits that could arise out of the oilimporting countries.
Our empirical analysis opens multiple avenues for further research. Sub-sample
analysis could be performed to better understand the discontinuity in the co-movement in
the short run/high frequency zone and a similar analysis could be performed with oil
exporting countries to explore better portfolio diversification opportunities.
ENDNOTES
*

We acknowledge and thank the anonymous referees for their useful comments. The remaining
errors are ours.
1
International Energy Statistics at Energy International Agency. We estimated the top world oil
importers based on the year 2012:http://www.eia.gov/cfapps/ipdbproject/iedindex3.cfm?
tid=5&pid=57&aid=3&cid=regions&syid=2009&eyid=2013&unit=TBPD
2
The estimation is undertaken in Matlab-R2014a using grinsted-wavelet-coherenceb3b1867package.

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