- Email: [email protected]
The linkage of stock exchange markets between countries
363
Economics Letters 7 (1981) 363-369 North-Holland Publishing Company
THE LINKAGE OF STOCK EXCHANGE MARKETS BETWEEN COUNTRIES An Empirical Study of Share Price Co-movements in Eleven Industrial Countries M.M.G.
FASE
De Nederlandsche Bunk N. V., 1000 A B Amsterdam, The Netherlands Erusmus Unioersi
21 July 1981
The results of a Pierce-Haugh dependency test on stock market indices in I I industrial countries are reported and a causality test for the Amsterdam stock exchange is applied.
1. Introduction Economic theory often assumes complete or virtually complete mobility of capital. Consequently, a policy of, for instance, increasing interest rates under a system of fixed exchange rates induces capital flows to the country concerned, which continue until spontaneous adjustment has caused the domestic level of interest rates to become equal to the world level. Thus the ultimate result is merely a change in the composition of the portfolio. At the other end of the scale, there is the view that national capital markets are segmented markets because of a lack of capital mobility brought about by, for instance, divergent expectations or risk perceptions. Consequently within a fixed exchange rate regime, monetary policy is a powerful instrument. To the extend that there is mobility of capital, it is reflected in a convergence of international interest rate levels or in strong share price co-movements. Regarding interest rates, the findings obtained by Fase (1976) and Volker (1980) suggest a high degree of financial integration under a system of fixed exchange rates. The results of studies, based on share prices, are less clear. Contrary to the results of Ripley (1973) and Fase et al. (1979), those of Agmon (1972) 0165-1765/81/0000-0000/$02.75
0 1981 North-Holland
M.M.G.
364
Fuse / Linkage of stock exchunge markets between countries
and La Societe G&&ale de Banque (1973) lend support to the hypothesis of an integrated financial market. This paper reports the results of a Pierce-Ha@ dependency test to examine the degree of integration or segmentation of stock markets in 11 industrial countries. In addition a Granger-Sims type causality test is performed to identify the dependency of the Amsterdam stock exchange on Wall Street. Unlike earlier studies, the present paper concentrates on the lag and error structure, as many results are suspect in terms of spurious relationships. The data used are mid-week figures for the period 1971- 1976, taken from Fase et al. (1979). These figures are all share price indices as supplied by the national agencies and published in, e.g., the Financial Times.
2. Methodology
and results
The individual series for each country have been cleared of spurious relationships by filtering as suggested by Haugh (1976) and Pierce (1977). To this end, for each series an ARIMA (p,d,q) model has been estimated. This model takes the form of +J L) v ‘z, = e,( L)a,, where $I~(L) and 6’,(L) are polynomials in L, while 7’ = (1 - L)” is the dth difference operator. a, is white noise. The estimated ARIMA models along with the Box-Pierce portemanteau statistics against serial correlation of residuals are shown in table 1. Filtering the series by the estimated models removes serial correlation. Cross correlations fjj(k) at lag k between the two residual white noise series cii and sj are calculated in accordance with
Following Haugh (1976) an overall measure of dependence series i and j is obtained by the statistics Sij with
between
the
m2
sij = n2
x
b -
b’+‘?;(k),
k=-m,
where
'ij N approach in mentation is pre-whitened
Xi, +f”2.+ I and n is the length of the series. Thus our exammmg the question of international stock market segequivalent to looking at the extent of covariation among share prices in different countries.
M. M. G. Fuse / Linkage of stock exchange murk& Table 1 ARIMA models and diagnostic checks 197 1- 1976 (midweek observations). a i I
for share
prices
ARIMA
models
Country
Estimated
Netherlands
v ZI =(I +o.l44LZ)q
between countries
in eleven
industrial
365
countries,
Box-Pierce statistics x;, =
9.8
(2.6) 2
United Kingdom
x:, = 9.0
vz,=(l+0.160L2)u, (2.9)
3
United
4
Belgium
States
vz,=u, (I-0.297L)
vr,=cr,
&=
5.6
x:, =
8.0
&=
8.9
&=
9.9
(5.5) 5
France
(I-0.227L)
vz,=(l+O.l46L’)a,
(4.1) 6
Japan
(2.6)
Vr,=(1-0.105L*+0.153L3)a, (1.9)
Canada
(I-0.174L)
(2.7) x:, = 13.5
vr,=a,
(3.1) Australia
x:,=11.7
~r,=(1+0.218L~)u, ($9)
Switzerland
x:, = 6.9
vz,=(I+o.l51L’)cr, (2.7)
W. Germany
vz,=(l+o.l5lL*-o.1o4L6)u, (2.7)
Italy
~z,=(1+0.141L~-0.172L’)a, (2.5)
a Figures
in parentheses
are t-statistics;
x:, =
8.7
(1.9) &
= 10.4
(3.1)
the suffix n in xi indicates
degrees of freedom.
The results in table 2 indicate that, with the notable exception of Italy, all the S-statistics for two sided lag length of 13 exceed the 95% critical level of 40.11 with 27 degrees of freedom. This means that, Italy apart, none of the national stock prices indices varies independently of the other national indices. This result holds true, although not reported here, for two sided lag length of 23 as well as for a lag length of 0, i.e., contemporaneous correlation. Thus we may conclude that the national stock markets are closely linked, indicating a considerable degree of financial integration.
according
53.31 49.17 42.53 40.36 47.49 54.68 49.93 48.05 35.83
2
the countries
59.25 15.22 III.00 86.57 65.41 73.07 58.45 98.29 95.43 46.49
2 3 4 5 6 7 8 9 10 II
a i, j indicate
I
S,,, for m, =mz = 13. a
I
i
Table 2 Test statistic
.
to table I
51.50 55.63 48.54 174.72 50.36 77.09 30.08 37.09
3
91.16 42.85 65.20 35.79 92.6 I 51.38 81.54
4
31.73 67.99 44.12 82.71 63.28 32.69
5
41.04 54.07 51.32 40.80 40.90
6
45.60 72.90 26.72 22.15
I
60.05 40.34 42.93
8
76.63 37.26
9
35.78
IO
D
iT
b
\ f.
M.M.G.
Fuse / Linkage
of stockexchange
x
2 +
00000
4 +
murkets between countries
%;;4 +++
000
361
368
M.M.G.
Fax
3. Wall street and damrak Statistical evidence for the view that the share prices on the Amsterdam Stock exchange, i.e. Damrak, are mainly determined by foreign stock markets, goes back to the prewar studies of, Donner (1934) and Tinbergen (1939). The statistical methodology employed in the present paper also offers a means to examine the direction of causality. Cross correlation of ARIMA residuals at any negative lag would indicate that country i may lead Dutch stock market prices or, following Pierce (1977) that country i ‘causes’ movement on the Amsterdam stock market. Table 3 sets out the lags of univariate residual cross correlation among the countries studied vis-a-vis the Netherlands, which were significant at 95% confidence interval. This pattern is hardly affected if we consider 975% and 99% confidence intervals. The results indicate only negative lags for the US and Japan with respect to Dutch share prices and predominantly negative lags for Australia, Belgium, Canada and Switzerland, while for UK, France, W. Germany and Italy feedback relationships seem to exist. In view of this pattern we may conclude that Wall street ‘causes’ share price movements in Damrak. Interestingly enough significant contemporaneous correlation seems to exist with all countries considered with the exception of Australia which may be considered ‘causal’ to Damrak too. However, this is not we want to investigate here, as we are mainly interested in Wall Street. The results seem to corroborate the fact that the majority of national shares are non-tradables outside the country. However, because in each country domestic shares are substitutes for a few internationals, the substitutability carries over internationally. Our results offer strong statistical evidence for the hypothesis of internationally linked stock markets.
References Agmon, T., 1972, The relations among equity markets: A study of share price co-movements in the United States, United Kingdom, Germany and Japan, Journal of Finance 27, 839-855. Donner, 0.. 1934, Die Kursbildung am Aktienmarkt, Vierteljahreshefte zur Konjunkturforschung, Sonderheft 36 (Institut ftir Konjunkturforschung, Berlin). Fax, M.M.G., 1976, The interdependence of short term interest rates in the major financial centres of the world, Kyklos 29, 63-96. Fase, M.M.G. and E.W. van den Berg, 1979, Tussen Damrak en de rest van de wereld, Maandblad voor Accountancy en Bedrijfshuishoudkunde 53, 174- 189.
M.M.G.
Fuse / Linkuge of stock exchange markets between countries
369
Haugh, L.D., 1976, Checking the independence of two covariance-stationary time-series: A univariate residual cross-correlation approach, Journal of the American Statistical Association 71, 378-385. Pierce, D.A., 1977, Relationships-and the lack thereof-between economic time series, with special reference to money and interest rates, Journal of the American Statistical Association 72,
Economics Letters 7 (1981) 363-369 North-Holland Publishing Company
THE LINKAGE OF STOCK EXCHANGE MARKETS BETWEEN COUNTRIES An Empirical Study of Share Price Co-movements in Eleven Industrial Countries M.M.G.
FASE
De Nederlandsche Bunk N. V., 1000 A B Amsterdam, The Netherlands Erusmus Unioersi
21 July 1981
The results of a Pierce-Haugh dependency test on stock market indices in I I industrial countries are reported and a causality test for the Amsterdam stock exchange is applied.
1. Introduction Economic theory often assumes complete or virtually complete mobility of capital. Consequently, a policy of, for instance, increasing interest rates under a system of fixed exchange rates induces capital flows to the country concerned, which continue until spontaneous adjustment has caused the domestic level of interest rates to become equal to the world level. Thus the ultimate result is merely a change in the composition of the portfolio. At the other end of the scale, there is the view that national capital markets are segmented markets because of a lack of capital mobility brought about by, for instance, divergent expectations or risk perceptions. Consequently within a fixed exchange rate regime, monetary policy is a powerful instrument. To the extend that there is mobility of capital, it is reflected in a convergence of international interest rate levels or in strong share price co-movements. Regarding interest rates, the findings obtained by Fase (1976) and Volker (1980) suggest a high degree of financial integration under a system of fixed exchange rates. The results of studies, based on share prices, are less clear. Contrary to the results of Ripley (1973) and Fase et al. (1979), those of Agmon (1972) 0165-1765/81/0000-0000/$02.75
0 1981 North-Holland
M.M.G.
364
Fuse / Linkage of stock exchunge markets between countries
and La Societe G&&ale de Banque (1973) lend support to the hypothesis of an integrated financial market. This paper reports the results of a Pierce-Ha@ dependency test to examine the degree of integration or segmentation of stock markets in 11 industrial countries. In addition a Granger-Sims type causality test is performed to identify the dependency of the Amsterdam stock exchange on Wall Street. Unlike earlier studies, the present paper concentrates on the lag and error structure, as many results are suspect in terms of spurious relationships. The data used are mid-week figures for the period 1971- 1976, taken from Fase et al. (1979). These figures are all share price indices as supplied by the national agencies and published in, e.g., the Financial Times.
2. Methodology
and results
The individual series for each country have been cleared of spurious relationships by filtering as suggested by Haugh (1976) and Pierce (1977). To this end, for each series an ARIMA (p,d,q) model has been estimated. This model takes the form of +J L) v ‘z, = e,( L)a,, where $I~(L) and 6’,(L) are polynomials in L, while 7’ = (1 - L)” is the dth difference operator. a, is white noise. The estimated ARIMA models along with the Box-Pierce portemanteau statistics against serial correlation of residuals are shown in table 1. Filtering the series by the estimated models removes serial correlation. Cross correlations fjj(k) at lag k between the two residual white noise series cii and sj are calculated in accordance with
Following Haugh (1976) an overall measure of dependence series i and j is obtained by the statistics Sij with
between
the
m2
sij = n2
x
b -
b’+‘?;(k),
k=-m,
where
'ij N approach in mentation is pre-whitened
Xi, +f”2.+ I and n is the length of the series. Thus our exammmg the question of international stock market segequivalent to looking at the extent of covariation among share prices in different countries.
M. M. G. Fuse / Linkage of stock exchange murk& Table 1 ARIMA models and diagnostic checks 197 1- 1976 (midweek observations). a i I
for share
prices
ARIMA
models
Country
Estimated
Netherlands
v ZI =(I +o.l44LZ)q
between countries
in eleven
industrial
365
countries,
Box-Pierce statistics x;, =
9.8
(2.6) 2
United Kingdom
x:, = 9.0
vz,=(l+0.160L2)u, (2.9)
3
United
4
Belgium
States
vz,=u, (I-0.297L)
vr,=cr,
&=
5.6
x:, =
8.0
&=
8.9
&=
9.9
(5.5) 5
France
(I-0.227L)
vz,=(l+O.l46L’)a,
(4.1) 6
Japan
(2.6)
Vr,=(1-0.105L*+0.153L3)a, (1.9)
Canada
(I-0.174L)
(2.7) x:, = 13.5
vr,=a,
(3.1) Australia
x:,=11.7
~r,=(1+0.218L~)u, ($9)
Switzerland
x:, = 6.9
vz,=(I+o.l51L’)cr, (2.7)
W. Germany
vz,=(l+o.l5lL*-o.1o4L6)u, (2.7)
Italy
~z,=(1+0.141L~-0.172L’)a, (2.5)
a Figures
in parentheses
are t-statistics;
x:, =
8.7
(1.9) &
= 10.4
(3.1)
the suffix n in xi indicates
degrees of freedom.
The results in table 2 indicate that, with the notable exception of Italy, all the S-statistics for two sided lag length of 13 exceed the 95% critical level of 40.11 with 27 degrees of freedom. This means that, Italy apart, none of the national stock prices indices varies independently of the other national indices. This result holds true, although not reported here, for two sided lag length of 23 as well as for a lag length of 0, i.e., contemporaneous correlation. Thus we may conclude that the national stock markets are closely linked, indicating a considerable degree of financial integration.
according
53.31 49.17 42.53 40.36 47.49 54.68 49.93 48.05 35.83
2
the countries
59.25 15.22 III.00 86.57 65.41 73.07 58.45 98.29 95.43 46.49
2 3 4 5 6 7 8 9 10 II
a i, j indicate
I
S,,, for m, =mz = 13. a
I
i
Table 2 Test statistic
.
to table I
51.50 55.63 48.54 174.72 50.36 77.09 30.08 37.09
3
91.16 42.85 65.20 35.79 92.6 I 51.38 81.54
4
31.73 67.99 44.12 82.71 63.28 32.69
5
41.04 54.07 51.32 40.80 40.90
6
45.60 72.90 26.72 22.15
I
60.05 40.34 42.93
8
76.63 37.26
9
35.78
IO
D
iT
b
\ f.
M.M.G.
Fuse / Linkage
of stockexchange
x
2 +
00000
4 +
murkets between countries
%;;4 +++
000
361
368
M.M.G.
Fax
3. Wall street and damrak Statistical evidence for the view that the share prices on the Amsterdam Stock exchange, i.e. Damrak, are mainly determined by foreign stock markets, goes back to the prewar studies of, Donner (1934) and Tinbergen (1939). The statistical methodology employed in the present paper also offers a means to examine the direction of causality. Cross correlation of ARIMA residuals at any negative lag would indicate that country i may lead Dutch stock market prices or, following Pierce (1977) that country i ‘causes’ movement on the Amsterdam stock market. Table 3 sets out the lags of univariate residual cross correlation among the countries studied vis-a-vis the Netherlands, which were significant at 95% confidence interval. This pattern is hardly affected if we consider 975% and 99% confidence intervals. The results indicate only negative lags for the US and Japan with respect to Dutch share prices and predominantly negative lags for Australia, Belgium, Canada and Switzerland, while for UK, France, W. Germany and Italy feedback relationships seem to exist. In view of this pattern we may conclude that Wall street ‘causes’ share price movements in Damrak. Interestingly enough significant contemporaneous correlation seems to exist with all countries considered with the exception of Australia which may be considered ‘causal’ to Damrak too. However, this is not we want to investigate here, as we are mainly interested in Wall Street. The results seem to corroborate the fact that the majority of national shares are non-tradables outside the country. However, because in each country domestic shares are substitutes for a few internationals, the substitutability carries over internationally. Our results offer strong statistical evidence for the hypothesis of internationally linked stock markets.
References Agmon, T., 1972, The relations among equity markets: A study of share price co-movements in the United States, United Kingdom, Germany and Japan, Journal of Finance 27, 839-855. Donner, 0.. 1934, Die Kursbildung am Aktienmarkt, Vierteljahreshefte zur Konjunkturforschung, Sonderheft 36 (Institut ftir Konjunkturforschung, Berlin). Fax, M.M.G., 1976, The interdependence of short term interest rates in the major financial centres of the world, Kyklos 29, 63-96. Fase, M.M.G. and E.W. van den Berg, 1979, Tussen Damrak en de rest van de wereld, Maandblad voor Accountancy en Bedrijfshuishoudkunde 53, 174- 189.
M.M.G.
Fuse / Linkuge of stock exchange markets between countries
369
Haugh, L.D., 1976, Checking the independence of two covariance-stationary time-series: A univariate residual cross-correlation approach, Journal of the American Statistical Association 71, 378-385. Pierce, D.A., 1977, Relationships-and the lack thereof-between economic time series, with special reference to money and interest rates, Journal of the American Statistical Association 72,