On the Efficiency of Stock Markets: A Case of Selected OPEC Member Countries


Thursday, February 28, 2019  11:35AM / CBN

The study investigates the stock market efficiency of selected OPEC member countries within the context of random walk hypothesis and volatility approaches using monthly data on stock market indices from January, 2005 to April, 2016. Parametric (variance ratio: homoskedastic and heteroskedastic martingale), nonparametric (the Wright ranks and scores) tests and ARCHtype estimation are performed. Results of both parametric and nonparametric tests indicate that only Qatar’s stock market is weak-form efficient. The volatility results suggest that monthly stock returns of OPEC countries are volatile, with Qatar being most volatile and shocks to volatility of stock returns are asymmetric. The implications of this are that: first, investors should be conscious of these shocks when making risk-return decision of their portfolios; second, the results provide useful information to regulators to enable them develop safeguard mechanisms to shield the market from possible asymmetric information emanating from the participants.


The world market is witnessing progressive growth in recent times, evidenced by the world GDP growth rising from 2.0 percent in 2015 to 2.4 percent in 2016 and then to 3.0 percent in 2017 with an estimated growth of 3.1 percent in 2018 (World Bank, 2018). Consequently, the business environment is also showing signs of motivation for investors and this has has resulted in the listing of new, productive and profitable companies However, one important motivating factor for investing in equity is the ability to hedge risks and make more profit. Whether investors will be able to do this or not depends on the nature of efficiency of the market (Fama, 1970). Efficient market implies that the current price of a stock contains all past information such that no single investor can capitalize on any new information to make extra profit (Fama, 1970). Consequently, there will be no under/overvalued assets offering lower/higher than expected returns.

A special case of market efficiency hypothesis is the weak-form or the random walk hypothesis which states that stock price movements do not depend on past information and so, investors have no incentive to hedge risk they are exposed to. However, real-world experience has shown that some investors have been able to use past information to determine the future price and consequently, they have opportunities to earn a supernormal profit (Pandey, 2010). This paper seeks to investigate the nature of market efficiency in the Organization of Petroleum Exporting Countries (OPEC) by looking at seven member countries. The motivation for studying the case of OPEC is: First, the oil sector has been linked to the economic performance of the oil producing nations.

The OPEC is an Organization of 15 oil producing countries that coordinate and unify the petroleum policies of its members and also ensure oil market stabilization. These countries are: Algeria, Angola, Ecuador, Equatorial Guinea, Gabon, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Congo, Saudi Arabia, United Arab Emirate (UAE) and Venezuela. Qatar has announced that it will pull out of OPEC in January 2019, on the ground that the country is planning to focus attention on the production of natural gas. Available evidence shows that the share of oil exports in total exports of these countries has been around 70 percent while its share in GDP has been on average, 38 percent in the last 10 years. Hence, any situation in the oil sector that alters the volume produced or price charged would influence economic activities which will in turn, affect the confidence of investors in the equity markets of the member countries (World Bank, 2017).

Second, the demand for OPEC crude oil is expected to increase to about 40 million barrels per day (40mb/d) in 2040 up from 32 mb/d in 2018 while the growth rate of OPEC is estimated to increase from 1.8 percent in 2017 to 2.5 percent in 2018 but could drop to 2.3 percent in 2019 (This information was obtained fromwww.momr.opec.org/). Furthermore, many OPEC member countries like Qatar, Nigeria, Saudi Arabia, and UAE have prospects for high economic growth (Omoh et al., 2018). The rising demand for crude oil and promising economic growth could motivate investors to venture into the equity market of these countries.

Third, the market capitalization of the oil companies in the OPEC countries was on average 44 percent (OPEC, n.d), suggesting that market capitalization of the oil sector could influence overall stock indices of these countries. Even if oil companies do not dominate the market, as long as the economy is promising, investors could decide to invest in equity of these countries. Another motivation stems from country-specific distortions in economic activity which could motivate investors to invest in other oil producing countries where such distortions are absent or less noticeable.

The study by Guidi and Tarbert (2006) indicates that market returns of the UK and US are affected by business-based factors such as OPEC policy decisions during periods of conflict. These factors will certainly make stock market inefficient. Stability of the stock returns helps investors to decide when and where to invest. However, given various country-specific distortions and/or frequent portfolio mix, the market may be volatile and the higher the volatility, the riskier the investments. Interestingly, volatility is a common phenomenon in well-developed financial markets, but most OPEC members have been identified as emerging markets indicating that the stock returns in these counties could exhibit or have the potential for high volatility. An emerging market is a market that have the potential to graduate to developed market or a market that is marked to become developed in the future.

Providing further information about the behavior of the stock markets of OPEC member countries will help investors make adequate risk-return decision. Many statistical methods have been advanced in testing the efficiency of stock markets. The methods range from unit root, stationarity, through variance ratio tests to volatility models and fractional integration technique. The unit root tests provide the necessary condition for efficiency while variance ratio provides sufficient condition, however, all these tests are nonparametric in nature.

The use of volatility models, that is the generalized autoregressive conditional heteroskedasticity (GARCH) methods have been found useful not only to control for the influence of previous conditional variance or previous conditional mean (GARCH-M) but also for testing whether the shock to stock market returns is positive or negative and whether such positive (negative) shock more than neutralize other negative (positive) shock. Notwithstanding the weakness of the variance ratio tests, a significant number of authors have utilized it in studies of many countries and regions (see for example Urquhart and McGroarty, 2016; Guidi and Gupta, 2014; Jamaani and Roca, 2015).

This study carries out various variance ratio and volatility tests alongside the necessary condition for random walk in order to reveal the consistency or otherwise of the methods in investigating the efficiency of the stock market of selected OPEC member countries. Also, the existence and nature of the volatility of stock returns in this Cartel are established. The organization of the rest of the article is as follows: section 2 provides a review of some of the existing literature. The data employed and as well as the methodology utilized in the study are presented in Section 3. Section 4 presents the results and discussions and section 5 concludes and provides some policy implications based on the underlying results.

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