Cointegration Relationships Between Markets Under Different Currency Systems: Post 2007 Financial Crisis

Abstract

In this study, we examine the cointegration relationships between the US stock market and those of 76 international markets (with 22 developed, 24 emerging, and 29 frontier markets) in the post 2007 Financial Crisis period. Overall, we find that international stock markets are not cointegrated with the US stock market. Over the long run, international portfolio diversification is an effective way to manage country risk. Stock markets in countries with free-floating exchange rate system seem to be more integrated with the US stock market. In other words, US investors may enjoy greater benefits from portfolio diversification by investing in countries whose currencies are not free-floating. However, during a crisis, stock markets becomes more cointegrated as observed by the spike in the recursive cointegration graphs. A financial crisis in one country can have an impact on the stock market of another country. The observed contagion effect makes international portfolio diversification strategy less effective during a crisis.