Testing the Financial Cointegration of Equity Markets:Analysis of Developed and Developing Economies

Abstract

This study explored the financial co-integration of equity markets of developed and developing countries for the period of January 2001 to October 2011. Ten equity markets were included in this study i.e. Pakistan, Australia, France, Germany, United Kingdom, Japan, United State of America, Canada, India and Hong Kong. Multivariate Co-integration with weekly based data was used for analysis. Results found from the study that the KSE offers over all highest return of 46% weekly at appropriate risk tolerance level. The equity markets of Australia, France, Germany, United Kingdom, Japan, United State of America, Canada, India and Hong Kong show less return on high risk or above average risk level as compare to equity market of Pakistan which shows the good economic conditions of the country if other things remaining the same. Equity market of Pakistan is not co integrated with all other stock markets except the equity market of TSX. The Non-cointegration of markets shows that there exist the chances of portfolio diversification. Investors from these countries can be benefited from the diversification of their own structured portfolios on the basis of their own ranked risk profile and risk appetite of investment horizon. Behavioral biases and framing their investing decisions under different risk and return trade off pattern in different environment should be considered for taking the maximum edge from portfolio diversification. According to both multivariate co integration analysis Max-Eigen value statistics and multivariate co-integration analysis trace statistics there are 5 co integrating equations at the 0.05 level that shows there exist five common patterns in our selected series of equity markets and shows there exist long run relationship. Impulse response analysis and variance decomposition analysis shows that KSE and BOMBAY stock market are seems to some extent out of organism as most of these markets shocks are explained by these own innovations.

Keywords: co-integration, equity markets, multivariate co-integration analysis