ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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Evidence from India

Impact of State Intervention in Oil Pricing on Stock Market Volatility

The Indian economy deregulated its oil price regime and moved from state-administered to market-linked pricing. This study examines the impact of deregulation on volatility transmission between international oil prices and Indian stock markets. The findings show that due to continual interventions in the form of taxation changes and price freeze during elections, not only did the short-term spillover of oil prices on stock markets strengthen, but the long-term spillover also continues to remain, despite oil price deregulation. This implies that after moving to market-determined pricing, there should be no tinkering with the oil-pricing mechanism by policymakers to ensure the desired stability in stock markets.

 

The impact of oil prices on stock market volatility is well-discussed in the extant literature with mixed results (Arouri et al 2011; Lin et al 2014; Pandey and Vipul 2018; Salisu and Oloko 2015). However, there is scant research that examines how this relationship changes in the presence of regulatory interventions in domestic oil prices. The domestic oil prices can be either market-determined or state-administered. Market-determined domestic oil prices move in line with the changes in the international crude oil prices. State-administered pricing means that the domestic oil prices are fully controlled by the domestic governments in order to keep consumers insulated from high inflation in the events of a spike in ­international crude oil prices. The theoretical relationship ­between stock market volatility under state-administered pricing differs from market-determined oil pricing. In a state-­administered regime, the domestic oil prices, although not constant, tend to be much more stable and do not adjust quickly in line with international oil prices. This results in negligible or no short-term uncertainty in stock markets from fluctuations in international oil prices. However, when the divergence bet­ween international and domestic oil prices increases, the likelihood of government passes on changed international prices also increases. Stock market participants are, however, uncertain about the timing and magnitude of this government intervention that may come in the future. This creates long-term uncertainty among them. On the contrary, in market-­determined pricing, there is only a short-term volatility transmission from oil prices on stocks and no long-term spillover as the domestic oil prices keep adjusting in tandem with the ­international prices.

The empirical evidence examining the association between stock market volatility and domestic oil pricing mechanism is scant. To the best of our knowledge, China is the only country where major studies have been conducted. Market-oriented pricing reform in domestic oil prices resulted in long-term spillover disappearing from oil and stock markets, because of steadiness in the Chinese stock markets after a stable econo­mic oil policy environment (Bouri et al 2017). They further found evidence of strengthening causality-in-mean relationship from oil prices to Chinese stock markets after the pricing reform. The reason behind this is that the transmission of ret­urns was largely blocked due to limited frequency of changes in domestic prices before 27 March 2013, when prices were state-administered.

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Updated On : 4th Feb, 2022
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