Financial market integration, stock markets and exchange rate dynamics in Eastern Europe

International capital flows in a system of flexible exchange rates will affect stock market dynamics and stock market developments should affect capital flows and the exchange rate respectively. In this analysis, four accession countries have been considered in order to examine any potential links between nominal stock market index and nominal exchange rate. For this purpose, monthly data were used. The cointegration concept was employed for testing long-term links and the VAR approach for short-term links. Finally, Granger causality tests were employed for the determination of the exogenous and endogenous variables. The results show that significant links exist between the stock market index and the foreign exchange rate for three countries, where for Poland, both long-term and short-term links exist. The other key aspect considered in this analysis is the stock market integration in Eastern European countries. Our analysis shows that the integration of the stock markets in Eastern European countries seems to be rather week except for the Hungarian stock market. This means that only the Hungarian stock market is integrated. A standard regression analysis reveals that the Hungarian market exhibits a strong co-movement with the benchmark market, i.e. the German stock market. Furthermore, there is a clear-cut result with respect to the dynamic of stock market synchronization. The degree of synchronization increased particularly in the period 2005–2008.