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The integration of capital markets: correlation analysis

Author

Listed:
  • Ioan TRENCA
  • Eva DEZSI

    (Babes-Bolyai University Cluj-Napoca)

Abstract

The financial theory predicts that gains can be achieved through international portfolio diversification, if the different markets are not correlated. As we can see the level of interaction or independence between markets has an important impact of the investments, in means of risk and return. International portfolio diversification can lead to efficient asset allocation and reduce risk, assets associated with similar levels of risk are anticipated to have similar levels of return in integrated markets. But, if these markets are driven by a common shock, for example the present financial crisis, this will have an immediate effect on them. This paper examines the short term relationships between the biggest stock exchanges in the world, and also the dynamics of these market integrations. Unconditional correlation estimates and mobile correlations are first employed; the next step in the analysis is to test each index series for the presence of unit roots, which shows whether the series are nonstationary. Nonstationarity is a precondition for cointegration, additionally all the series must be integrated in the same order. For this I apply the ADF, PP and the KPSS test. Once the stationarity requirements are met the Granger, Johansen and Pedroni tests are used to determine whether the time series are cointegrated.

Suggested Citation

  • Ioan TRENCA & Eva DEZSI, 2010. "The integration of capital markets: correlation analysis," Finante - provocarile viitorului (Finance - Challenges of the Future), University of Craiova, Faculty of Economics and Business Administration, vol. 1(12), pages 44-53, December.
    • Handle: RePEc:aio:fpvfcf:v:1:y:2010:i:12:p:44-53
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    File URL: http://feaa.ucv.ro/FPV/012-06.pdf
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    References listed on IDEAS

    as
    1. Peter Pedroni, 1999. "Critical Values for Cointegration Tests in Heterogeneous Panels with Multiple Regressors," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 61(S1), pages 653-670, November.
    2. Schotman, Peter C & Zalewska, Ania, 2005. "Non-synchronous Trading and Testing for Market Integration in Central European Emerging Markets," CEPR Discussion Papers 5352, C.E.P.R. Discussion Papers.
    3. Manolis Syllignakis & Georgios Kouretas, 2006. "Long And Short-Run Linkages In Cee Stock Markets: Implications For Portfolio Diversification And Stock Market Integration," William Davidson Institute Working Papers Series wp832, William Davidson Institute at the University of Michigan.
    4. repec:bla:obuest:v:61:y:1999:i:0:p:653-70 is not listed on IDEAS
    5. Schotman, Peter C. & Zalewska, Anna, 2006. "Non-synchronous trading and testing for market integration in Central European emerging markets," Journal of Empirical Finance, Elsevier, vol. 13(4-5), pages 462-494, October.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    capital markets integration; correlation analysis;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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