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Openair@RGU the Open Access Institutional Repository at Robert Gordon University OpenAIR@RGU The Open Access Institutional Repository at Robert Gordon University http://openair.rgu.ac.uk Citation Details Citation for the version of the work held in ‘OpenAIR@RGU’: SANUSI, M. S., 2015. Market efficiency, volatility behaviour and asset pricing analysis of the oil & gas companies quoted on the London Stock Exchange. Available from OpenAIR@RGU. [online]. Available from: http://openair.rgu.ac.uk Copyright Items in ‘OpenAIR@RGU’, Robert Gordon University Open Access Institutional Repository, are protected by copyright and intellectual property law. If you believe that any material held in ‘OpenAIR@RGU’ infringes copyright, please contact [email protected] with details. The item will be removed from the repository while the claim is investigated. MARKET EFFICIENCY, VOLATILITY BEHAVIOUR AND ASSET PRICING ANALYSIS OF THE OIL & GAS COMPANIES QUOTED ON THE LONDON STOCK EXCHANGE Muhammad Surajo Sanusi A thesis submitted in partial fulfilment of the requirements of the Robert Gordon University for the degree of Doctor of Philosophy June 2015 i Abstract This research assessed market efficiency, volatility behaviour, asset pricing, and oil price risk exposure of the oil and gas companies quoted on the London Stock Exchange with the aim of providing fresh evidence on the pricing dynamics in this sector. In market efficiency analysis, efficient market hypothesis (EMH) and random walk hypothesis were tested using a mix of statistical tools such as Autocorrelation Function, Ljung-Box Q-Statistics, Runs Test, Variance Ratio Test, and BDS test for independence. To confirm the results from these parametric and non-parametric tools, technical trading and filter rules, and moving average based rules were also employed to assess the possibility of making abnormal profit from the stocks under study. In seasonality analysis, stock returns were tested for the day-of-the-week and month-of-the-year effects. Volatility processes, estimation, and forecasting were undertaken using both asymmetric and symmetric volatility models such as GARCH (1,1) and Threshold ARCH or TARCH (1,1,1) to investigate the volatility behaviour of stock returns. To determine the effect of an exogenous variable on volatility, Brent crude oil price was used in the models formulated as a variance regressor for the assessment of its impact on volatility. The models were then used to forecast the price volatility taking note of the forecasting errors for the determination of the most effective forecasting model. International oil price risk exposure of the oil and gas sector was measured using a multi-factor asset pricing model similar to that developed by Fama and French (1993). Factors used in the asset pricing model are assessed for statistical significance and relevance in the pricing of oil and gas stocks. Data used in the study were mainly the adjusted daily closing prices of oil and gas companies quoted on the exchange. Five indices of FTSE All Share, FTSE 100, FTSE UK Oil and Gas, FTSE UK Oil and Gas Producers, and FTSE AIM SS Oil and Gas were also included in the analysis. Our findings suggest that technical trading rules cannot be used to gain abnormal returns, which could be regarded as a sign for weak form market efficiency. The results from seasonality analysis have not shown any day-of-the-week or monthly effect in stock returns. The pattern of stock returns’ volatility can be estimated and forecasted, although the relationship between risk and return cannot be generalised. On a similar note, the relationship between volatility attributes and the efficient market hypothesis cannot be clearly established. However, we have established that volatility modelling can significantly measure the quantum of risk in the oil and gas sector. Market risk, oil price risk, size and book-to-market related factors in asset pricing models were found to be relevant in the determination of asset prices of the oil and gas companies. Keywords: Information efficiency, seasonality analysis, volatility, systematic risk, asset pricing, and forecasting. ii Table of Contents Title Page .............................................................................................. i Abstract ............................................................................................... ii List of Tables ....................................................................................... ix List of Figures ..................................................................................... xvi CHAPTER 1 INTRODUCTION ................................................................ 1 1.1 Background of the Study ................................................................ 1 1.2 Statement of the Problem ............................................................... 5 1.3 Aim and Objectives ........................................................................ 6 1.3.1 Aim ....................................................................................... 6 1.3.2 Objectives .............................................................................. 6 1.4 Justification of the Study ................................................................ 7 1.5 Originality and Contribution to Knowledge ........................................ 8 1.5.1 Originality ............................................................................... 8 1.5.2 Contribution to Knowledge ...................................................... 10 1.6 Structure of the Thesis ................................................................ 111 CHAPTER 2 ECONOMIC THEORY OF THE LONDON STOCK EXCHANGE . 12 2.1 Introduction ............................................................................... 12 2.2 London Stock Exchange and the UK Economy .................................. 13 2.3 Competitive Attributes of the London Stock Exchange ...................... 16 2.3.1 Pricing and Trading Volume Information Disclosure ..................... 16 2.3.2 Settlement and Clearing Processes ........................................... 18 2.3.3 Pricing Initial Public Offerings (IPOs) and Transaction Costs ......... 19 2.3.4 Membership and Annual Fees .................................................. 22 2.3.5 Member Firms of the London Stock Exchange and their Activities .. 23 2.3.6 Activities of Market Makers, Brokers and Institutional Investors .... 25 2.3.7 Regulatory Framework ........................................................... 26 2.3.8 Market Bureaucracy and Ease of Operations .............................. 29 2.3.9 Transparency and Competitive Practice ..................................... 30 2.4 Conclusion ................................................................................. 31 CHAPTER 3 STRUCTURE AND OPERATIONS OF THE LONDON STOCK EXCHANGE ........................................................................................ 33 3.1 Introduction ............................................................................... 33 3.2 Historical Trend of the London Stock Exchange ................................ 33 3.3 Market Structure of the Exchange .................................................. 38 iii 3.4 Operational Activities of the London Stock Exchange ........................ 42 3.5 Conclusion ................................................................................. 45 CHAPTER 4 OIL AND GAS SECTOR OF THE LONDON STOCK EXCHANGE ........................................................................................ 46 4.1 Introduction ............................................................................ 46 4.2 Oil and Gas Sector .................................................................... 46 4.2.1 Oil and Gas Producers ............................................................ 47 4.2.2 Oil Equipment, Services and Distribution ................................... 48 4.3 Oil and Gas Companies Quoted on the Alternative Investment Market.................................................................................... 48 4.4 Overview of the Market Performance of the Oil and Gas Sector ....... 49 CHAPTER 5 RESEARCH METHODOLOGY AND FRAMEWORK ................ 51 5.1 Introduction ............................................................................... 51 5.2 Research Philosophy .................................................................... 51 5.3 Research Design ......................................................................... 53 5.4 Research Questions and Hypotheses .............................................. 56 5.4.1 Research Questions ................................................................ 56 5.4.2 Research Hypotheses ............................................................. 58 5.5 Theoretical Framework ................................................................. 60 5.5.1 Random Walk Theory – Bachelier (1900) ................................... 61 5.5.2 Efficient Market Hypothesis – Fama (1970) ................................ 62 5.5.3 Autoregressive Conditional Heteroscedasticity (ARCH) Model – Engle (1982) ........................................................................ 63 5.5.4 Generalized Autoregressive Conditional Heteroscedasticity (GARCH) Model – Bollerslev (1986) ....................................................... 63 5.5.5 Threshold Autoregressive Conditional Heteroscedasticity (TARCH) Model – Glosten, Jagannathan, and Runkle (1993) ..................... 64 5.5.6 Capital Asset Pricing Model (CAPM) – Sharpe (1964), Lintner (1965), and Mossin (1966) .........................................
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