Integration Between the Baltic and International Stock Markets

Using cointegration tests, this paper analyzes the existence of long-run relationships among Baltic stock markets and major international stock markets, including the United States, Japan, Germany, the United Kingdom, and France. Bivariate and multivariate cointegration tests indicate a common trend linking Latvia to European markets. Evidence indicates that the German market dominates this long-run relationship. In general, short-term Granger causality indicates causality running from the European markets to the Baltic markets, as well as among the Baltic states, excepting Latvian and Lithuanian short-term effects on the Estonian market. Overall, the results suggest that international investors can obtain diversification benefits given a long-term investment horizon because of the low degree of integration between the Baltic and international capital markets.     

Integration of emerging stock markets with global stock markets

Financial integration for emerging economies should be seen as a long-term objective. In this paper, we examine stock market integration among five selected emerging stock markets (Brazil, China, Mexico, Russia and Turkey) and developed markets of the US, UK and Germany. The bounds testing approach to cointegration and error-correction modeling are used on monthly data from January 2001 to December 2014 to determine the short-run and long-run relationship between emerging stock market returns and the returns of the developed stock markets. The results show evidence of the existence of short-run integration among stock markets in emerging countries and the developed markets. However, the long-run coefficients for stock market returns in all emerging countries show a significant relationship only with Germany stock market return. The empirical findings in this study have important implications for academicians, international investors, and policymakers in emerging markets.     

The Risk Exposure of Emerging Equity Markets

The low correlation between returns in emerging equity marketsand industrial equity markets implies that the global investorwould benefit from diversification in emerging markets. Thisarticle explores the sensitivity of the emerging-market returnsto measures of global economic risk. When these traditionalmeasures of risk are used, the emerging markets have littleor no sensitivity. This finding is consistent with these markets'being segmented from world capital markets. However, the correlationbetween the emerging-market returns and the risk factors appearsto be changing over time.     

Portfolio diversification effects of trading blocs: The case of NAFTA

This study investigates the evolving nature of North American Free Trade Agreement (NAFTA) stock market interdependencies and their association with diversification gains from the perspective of US investors. The issues are addressed for both short- and long-run interdependencies through correlation of stock market returns and cointegration of stock market prices. The basic findings include: (1) the existence of a long-term relationship (a cointegration relation) which is time-varying and statistically unstable and (2) diversification gains with cointegration not consistently lower than without cointegration. Thus, per-unit-of-risk diversification gains to US investors from NAFTA stock markets are determined by return volatilities, return correlations and domestic market performance. Based on increased return volatilities and return correlations and the very small per-unit-of-risk diversification gains even when the US stock market performs poorly, US investors’ diversification gains have diminished since the implementation of NAFTA.     

Equity market integration in emerging Balkan markets

This paper examines long-run relationships among five Balkan emerging stock markets (Turkey, Romania, Bulgaria, Croatia, Serbia), the United States and three developed European markets (UK, Germany, Greece), during the period 2000-2009. Conventional, regime-switching cointegration tests and Monte Carlo simulation provide evidence in favour of a long-run cointegrating relationship between the Balkan emerging markets within the region and globally. Moreover, we apply the Asymmetric Generalized Dynamic Conditional Correlation (AG-DCC) multivariate GARCH model of Cappiello et al. (2006), in order to capture the impact of the 2007-2009 financial crisis on the time-varying correlation dynamics among the developed and the Balkan stock markets. Results show that stock market dependence is heightened, supporting the herding behaviour during the 2008 stock market crash period. Our findings have important implications for international portfolio diversification and the effectiveness of domestic policies, as these emerging markets are exposed to external shocks.     

On the stability of long-run relationships between emerging and US stock markets

While most studies have found no cointegration between emerging and US stock markets, some recent studies do find a long-run relationship exists between these markets. In view of these mixed findings, this study examines the stability of long-run relationships between a number of emerging stock markets and the US stock market using recursive cointegration analysis. The results show that no long-run relationship exists between emerging markets and the US market over most of the sample period throughout 1997. However, we do find clear evidence of cointegration in response to the recent global emerging market crisis in 1997–1998. We conclude that significant crisis events can change the degree of cointegration between international stock markets and, therefore, need to be taken into account in studies of long-run relationships between international stock markets.     

Capital Market Integration in the Middle East and North Africa

This paper studies capital market integration in Middle Eastern and North African (MENA) countries and its implications for international portfolio investment allocation. Starting with four cointegration methodologies, we significantly reject the hypothesis of a stable, long-run bivariate relationship between each of these markets and the European Monetary Union (EMU), the United States, and a regional benchmark. This indicates the existence of significant diversification opportunities for three categories of investors (EMU, world, and regional investors). A recursive analysis based on Barari (2004) suggests that recently, the MENA markets have started to move toward international financial integration. Investigating the effect of selected financial, economic, and political events on such a process, we extend the methodology and find that the markets react heterogeneously to the different categories of shocks. They should therefore not be treated as a bloc for global allocation purposes. Finally, after adjusting the integration levels by relative market capitalization, Israel and Turkey are the most promising markets in the region, followed by Egypt, Jordan, and Morocco. Tunisia and Lebanon seem to be lagging behind.     

Common stochastic trends among Far East stock prices: Effects of the Asian financial crisis

This paper investigates empirically the change(s) in the long-run relationship(s) between the stock prices of eight Far East countries around the Asian financial crisis of 1997-98. Further tests are conducted to check the change in the influence of the Japanese and the US stock markets in the Far East Region before, during and after the crisis. Empirical investigation is conducted by means of rolling correlation coefficients, the Johansen multivariate cointegration method, causality tests and band spectrum regression. Results show significant long-run relationship(s) and linkage between the Far East markets before, during, and after the crisis. The most significant linkage and relationship are found during the crisis period. Results mostly indicate larger US influence in all periods but some evidence of increasing Japanese influence is also shown.     

A note on the long-run benefits from international equity diversification for a Taiwan investor diversifying in the US equity market

This note provides evidence that long-run benefits exist for Taiwanese investors diversifying into the US equity market over the period of January 5, 1995 to February 16, 2001. The evidence is based on tests for pairwise cointegration between the Taiwanese national equity index and the equity index for the US. We use five cointegrating tests, namely, the Multivariate Trace statistic, Harris-Inder approach, the Johansen method, the KSS approach, and the partial structural model of Bai and Perron [Bai, J., & Perron, P. (2003). Computation and analysis of multiple structural change models. Journal of Applied Econometrics, 18, 1-22]. The results from these five tests are consistent and suggest that the Taiwanese stock market is not pairwise cointegrated with the US stock market. This finding should prove valuable to individual investors and financial institutions holding long-run investment portfolios in these two markets.     

Does a Held-to-Maturity Strategy Impede Effective Portfolio Diversification for Islamic Bond (Sukuk) Portfolios? A Multi-Scale Continuous Wavelet Correlation Analysis

There is a critical gap in the literature in studying the portfolio diversification opportunities available to sukuk investors and evaluating these in light of held-to-maturity strategies usually adopted by these investors. This article has made an initial attempt to study the portfolio diversification strategies for sukuk portfolios across heterogeneous investment horizons. Our findings critically indicate that returns between local currency sukuk in different markets generally have low levels of correlations across different investor holding periods, thus enabling both short and long-run portfolio diversification benefits. However, in contrast, international currency sukuk issued in different markets exhibits high levels of correlations in the longer-term investor holding periods. Also, in the domestic market context, returns on different classes of domestic sukuk are found to exhibit strong correlations in the longer-holding periods. Our findings critically highlight the feasibility of held-to-maturity sukuk investment strategies from a portfolio diversification perspective.     

Does the stock market predict real activity? Time series evidence from the G-7 countries

This paper extends one aspect of the US stock market study of Fama (1990) and Schwert (1990). We examine the relationship between industrial production (IP) growth rates and lagged real stock returns for the G-7 countries using both in-sample cointegration and error-correction models and the out-of-sample forecast-evaluation procedure of Ashley et al. (1980). The cointegration tests show a long-run equilibrium relationship between the log levels of IP and real stock prices, while the error-correction models indicate a correlation between IP growth and lagged real stock returns for all countries except Italy. The out-of-sample tests show that in several sub-periods the US, UK, Japanese, and Canadian stock markets enhance predictions of future IP.     

Selecting macroeconomic variables as explanatory factors of emerging stock market returns

Emerging stock markets have been identified as being at least partially segmented from global capital markets. As a consequence, it has been argued that local factors rather than global factors are the primary source of equity return variation in these markets. This paper seeks to address the question of whether local macroeconomic variables have explanatory power over stock returns in emerging markets. Moderate evidence is found to support this contention. Furthermore, using a principal components approach, two types of commonality in returns are examined. Evidence is found that supports commonality in the factors that drive return variation across emerging markets. A test is also conducted for identical sensitivity to a common set of extracted factors. While little evidence of common sensitivities is found when emerging markets are considered collectively, considerable commonality is found at the regional level. These results have implications for international investors as they suggest that the benefits from diversification are enhanced when the allocation of funds is spread across, rather than within, regions.     

Time-Varying World Market Integration

We propose a measure of capital market integration arising from a conditional regime-switching model. Our measure allows us to describe expected returns in countries that are segmented from world capital markets in one part of the sample and become integrated later in the sample. We find that a number of emerging markets exhibit time-varying integration. Some markets appear more integrated than one might expect based on prior knowledge of investment restrictions. Other markets appear segmented even though foreigners have relatively free access to their capital markets. While there is a perception that world capital markets have become more integrated, our country-specific investigation suggests that this is not always the case.     

Risk and return implications from investing in emerging European stock markets

The dynamic linkages and the effects of time-varying volatilities are investigated for major emerging Central European (CE) and developed stock markets. Risk and return implications for portfolio diversification to these markets are assessed, causal lead–lag relationships are identified and asymmetric volatility effects are evaluated. The presence of one cointegration vector indicates market comovements towards a stationary long-run equilibrium path. Central European markets tend to display stronger linkages with their mature counterparts rather than their neighbors. An asymmetric EGARCH model indicates varying but persistent volatility effects for the CE markets. International portfolio diversification can be less effective across cointegrated markets because risk cannot be reduced substantially and return can exhibit a volatile reaction to domestic and international shocks. The possibility of arbitrage short-run profits, however is not ruled out.     

Correlation in price changes and volatility of major Latin American stock markets

This paper seeks to investigate the short-run dynamics between five major Latin American stock markets (Argentina, Brazil, Chile, Colombia and Mexico). Unlike previous research on these markets, the joint distribution of stock returns is estimated as a vector autoregression (VAR) with innovations following an exponential GARCH process. Our study is carried out using closing stock market prices covering the period 25 May 1992 to 16 May 1997. The results revealed that these countries have significant first and second moment time dependencies. In general, the markets of these countries exhibit stronger volatility than mean spillovers. Further, our results indicate that these markets exhibit stronger volatility spillovers than other regions of the world. In view of these dependencies, the conditional correlations between these markets are different from their conventional simple counterparts. Since the correlation is the catalyst in portfolio diversification and an essential parameter in the calculation of the cost of capital, we anticipate that international investors and corporate managers will find our results very interesting.     

Economic interdependence and common stochastic trends: A comparative analysis between EMU and non-EMU stock markets

Whether economic interdependence among countries is a contributing factor to cointegration and common stochastic trends in international stock markets is indiscernible due to contradictory results from prior empirical work. This study aims to add clarity to this issue through a more distinct grouping of countries and methodological enhancements. A comparative analysis of cointegration is conducted between stock market price indices of major Economic and Monetary Union (EMU) and non-EMU countries. The conventional Johansen methodology is augmented with several diagnostic techniques (that have not been all inclusive in previous studies) to ensure the robustness of test results. Major findings pertinent to investors and policymakers are that economic interdependence appears to be the important contributing factor and that the U.S. stock market does not exert influences on long-run performances of other included stock markets. Furthermore, while the UK is not an EMU member, it may be viewed as a quasi EMU participant due to its stock market being cointegrated with and yet one of the common stochastic trends (besides those of Germany, Italy, and the Netherlands) within the EMU stock markets under investigation.     

Equality of Real Returns on Canadian and US Treasury Bills: A Fractional Cointegration Analysis

This paper empirically analyzes the long memory relationship between the real returns on Canadian and US Treasury bills. A fractional cointegration approach, instead of conventional integer integration (unit root) and cointegration approaches, is used in analyzing the relationship. The advantage of fractionally integrated models is that they allow a smooth transition from a stationary process to a unit-root process. Furthermore, such models embody unit-root models as a special case. The models are therefore more general and appropriate for empirical analysis. By using fractionally integrated models, one also resolves the problems of an inconsistency in test results associated with using unit root and cointegration approaches. Briefly, it is found that the real returns on Canadian and US Treasury bills are fractionally integrated and the order of integration is significantly less than unity. Furthermore, the difference between the real returns follows a stationary process. This indicates that the Canadian and the US capital markets as well as product markets are well integrated. Furthermore, the domestic monetary authorities will not be able to influence the domestic real interest rate independent of the other market in the long-run.     

Long-run purchasing power parity,prices and exchange rates in transition: The case of six Central and East European countries

This paper presents empirical results on the hypothesis of long-run purchasing power parity (PPP) with respect to the exchange-rate regimes in six Central and East European countries. The analysis employs cointegration theory to examine the movements of prices and exchange rates in transition to a market economy. Our results are based on system estimation procedures developed by Stock and Watson (1993) and Johansen (1991). We find moderate evidence to support long-run equilibria, however, the cointegrating vector values do not yield to easy interpretation and violate the symmetry and proportionality conditions suggested by PPP. We provide an explanation for such behavior and find that it is consistent with the existing literature on transition and foreign exchange markets.     

Economic engagement and within emerging markets integration

We explore the co-movements between emerging markets by employing dynamic conditional correlation approach. We additionally explore the factors that might drive the conditional correlations between emerging markets. We show that trade with the high income countries is a more important driver of the co-movements between emerging markets relative to trade with other emerging markets either within or outside the geographic region of the given country. We further document that the overall health of an economy, investment and market depth explain the correlation between emerging markets. Evidence is also provided that although, the recent emerging markets and global financial crises raised the correlation between emerging markets, not all country pair correlations increased around the period of the crisis. The findings show that economic engagement as opposed to geographic proximity is more relevant in describing within emerging markets integration. The findings suggest that diversification gains could be achieved by strategically investing across some emerging markets even in crisis periods.     

Mean reversion in Southeast Asian stock markets

This paper assesses the predictable component of South East Asian stock markets using a bootstrap resampling method to estimate the small sample distributions of variance ratio statistics. We find evidence of mean reversion in long horizon dollar adjusted excess returns. The robustness of the results is assessed by adjusting stock returns for potential time-varying expected returns and partial integration of these emerging markets into world capital markets. In all but one case, mean reversion is shown to be due to either time-variation of risk exposure and prices of risk or partial integration of the local market into world stock markets. These results clearly illustrate the dangers of testing market efficiency without carefully adjusting stock returns for time variation in expected returns and the partial integration of local markets into world markets.