Abstract
This paper examines the long-term linkages between seven Central and Eastern European (CEE) emerging stock markets and two developed stock markets, namely the German and the US markets. The stability of the long-run relationships is studied using recursive cointegration analysis. The results reveal that the financial linkages between the CEE markets and the world markets increased with the beginning of the EU accession process. Furthermore, the application of the Gonzalo and Granger (J Bus Econ Stat 13:27–35, 1995) methodology indicates that the examined stock markets are partially integrated, while there is also evidence that the emerging stock markets of Central and Eastern Europe except for Estonia together with the German and the US stock markets, have a significant common permanent component, which drives this system of stock exchanges in the long run. Finally, it is worthwhile to note that the global financial crisis of 2007–2009 caused a slowdown in the convergence process. In addition we find evidence that the Slovenian stock market exhibits a moderate increase in the transitory component and this may be attributed to the Slovenian full membership in the euro area.
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Notes
Lucas (1982) states that the important implication of integrated capital markets is the equalization among countries of marginal rates of substitution in consumption, both intertemporally and across states of nature. This paper does not attempt to address the question of international capital market integration and for the most part focuses on the purely statistical exercise of detecting and estimating cointegration relations or common stochastic trends.
During the period January 2004 to December 2004 the CEE stock exchanges under investigation recorded significantly high returns. The Romanian stock exchange recorded a return of 103.5%, the Slovakian 83.9%, the Hungarian 57.2%, the Estonian 57.1%, the Czech 50.9%, the Polish 27.9% and the Slovenian 24.7%.
Kasa (1992) is among the first studies that examine long-run convergence of major stock markets using cointegration techniques. Since then a voluminous literature has developed in the area and overall there is supportive evidence in favour of convergence of both major and emerging stock markets at least over the long-term.
The increased interest in the CEE stock exchanges is revealed by the increased market capitalization as well as the increased foreign participation in CEE stock exchanges (see Table 1).
iShares MSCI Eastern Europe 10/40 Exchange Traded Fund (ETF) launched on November 4, 2005 to offer exposure to companies in CEE emerging markets to international investors.
We select Germany and the US as the key developed markets because these markets are the biggest, in terms of market capitalization, in North America and the Eurozone, respectively, and they can serve as proxies for the rest of the mature markets in both regions, in depicting possible linkages with the emerging European stock markets examined. Furthermore, the German and the US markets have an influential role in emerging European stock market movements due to their significant investment flows in these markets (see Table 1).
Bulgaria, Latvia and Lithuania are not included in this study due to data inadequacy. Nevertheless, our sample is representative of the three different market regions, namely the Central and Eastern Europe (Czech Republic, Hungary, Poland, Slovakia, Slovenia), the Baltic (Estonia) and the Balkans (Romania).
As of this writing (January 2009), the crisis is ongoing.
The regression of ΔX t and X t - 1 on ΔX t - 1,...,ΔX t - k + 1 and μ gives the residuals R 0t and R 1t , respectively, and residual product matrices \( S_{ij} = T^{ - 1} \sum\nolimits_{t = 1}^T {R_{it} } R\prime _{jt} {\text{ }},{\text{ }}i,j = 0,1 \).
The time period was set to start in September 1997, when the calculation of the BET index started, while after 1997 the majority of the stock exchanges examined had lifted most of the restrictions on foreign investment.
Expressing the stock price indices in their national currencies restricts their changes to the movements in the stock prices only avoiding distortions of the cointegration analysis results induced by numerous devaluations of the exchange rates that have taken place in the CEE region during the period covered in our sample [see Voronkova (2003)].
However, we should note that due to the financial turmoil of 2007–2009 these stock markets lost at least 50% of their value from June to November 2008.
Romania has also followed a mass privatization program, but all of the newly privatized companies listed on an over-the-counter market, the RASDAQ. In December 1998, 5,946 companies were listed on the RASDAQ market.
ADRs are receipts for shares of stock in foreign companies that are held in a custodial account by or for a US bank. These receipts are traded on US exchanges in US dollars. ADRs entitle the owners to all dividends, capital gains or losses, and voting rights, just as if the underlying shares were owned directly.
There are ten categories which refer to controls on: Capital market securities, Money market instruments, Collective investment securities, Derivative and other instruments, Commercial credits, Financial credits, Guarantees, securities and financial backup facilities, Direct investment, Liquidation of direct investment and Real estate transactions.
The Capital Account Openness index is for 2002.
Prior to the estimation of the VECM model we conduct unit root and stationarity tests to determine the stochastic properties of the data. We employ the Elliot et al. (1996) and Elliot (1999) GLS augmented Dickey-Fuller and Ng and Perron (2001) GLS versions of the modified Phillips-Perron (1988) unit root tests. For robustness we also apply the Kwiatkowski et al. (1992) KPSS stationarity test. The results show that we are unable to reject the null hypothesis of a unit root in the data for the levels of all stock price series, whereas the returns are I(0) processes. To save space the results are available upon request.
The autocorrelation hypothesis is tested with the use of the Lagrange-Multiplier test, up to six lags. The LM-statistic is 79.15 with 0.53 p-value distributed as a chi-square with 81 dof.
Johansen (1995, Chapter 11, Corollary 11.2 and Theorem 11.3, pp. 161–162) defines a number of sub-models of the general model (2), under the assumption of cointegration and with successive restrictions on the deterministic part of the model (μ). We tested the five sub-models against each other using the likelihood ratio tests and concluded that the second model, in which there are no trends but a constant term is allowed in the cointegration relations, describes best the examined groups of markets.
To account for small sample bias we apply the small sample correction coefficient on the Likelihood Ratio Trace test as suggested by Reimers (1992).
Septhon and Larsen (1991) have shown that Johansen’s tests may be characterized by sample dependency
In the “X-representation” all the parameters of VECM are re-estimated during the recursions, while under the “R-representation” the short-run parameters are fixed to their full sample values and only the long-run parameters are re-estimated.
The results of the rolling window estimation are available upon request.
According to Dvorak and Podpiera (2006), the integration of the CEE stock markets increased in the months following the 2001 announcement of the EU enlargement.
The evidence on high correlation coefficients maybe due to the increased volatility of all the CEE stock markets during the last 15 months and it may be considered as an indication of financial contagion.
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Acknowledgments
An earlier version of this paper was presented at the 1st International Workshop in Economics and Finance, University of Peloponnese, Tripolis, 14–16 May 2007 and thanks are due to conference participants for many helpful comments and discussions. This paper has also benefited from comments by seminar participants at the University of Bern and the University of Crete. Syllignakis acknowledges generous financial support from PENED 2003 under research grant #03ED46 co-financed by E.U.-European Social Fund (75%) and the Greek Ministry of Development-GSRT (25%). Kouretas acknowledges financial support by a Marie Curie Transfer of Knowledge Fellowship of the European Community’s Sixth Framework Programme under contract number MTKD-CT-014288, as well as by the Research Committee of the University of Crete under research grant #2257. We also thank Panayiotis Diamandis, Anastassios Drakos, Dimitris Georgoutsos, George Karathanassis, Dimitris Moschos and Leonidas Zarangas for many helpful comments and discussions and Minoas Koukouritakis for providing us his Matlab code for the common trend eigenvalue problem. We also thank the Editor George Tavlas and an anonymous referee for valuable comments that improved the manuscript substantially. The usual caveat applies.
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Syllignakis, M.N., Kouretas, G.P. German, US and Central and Eastern European Stock Market Integration. Open Econ Rev 21, 607–628 (2010). https://doi.org/10.1007/s11079-009-9109-9
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DOI: https://doi.org/10.1007/s11079-009-9109-9
Keywords
- Central and Eastern European stock market integration
- Cointegration
- Common stochastic trends
- Permanent and transitory components