Common Stochastic Trends in Emerging Equity Markets

Abstract

Evidence suggests that stock markets in industrialized economies are increasingly integrated with the presence of common trends amongst national stock market indices. This implies that in the long run there is little gain from diversifying portfolios internationally. We investigate the existence of common trends in the increasingly important emerging equity markets of the Latin American and Asia‐Pacific regions. While we find evidence of common trends, we argue that this in itself does not rule out long‐run benefits to diversification. Examination of the composition of the common trends reveals that some countries do not enter that region’s common trend and returns in some countries do not react to movements in the common trend, a result that generalizes to the inclusion of both the USA and the UK. Thus, even though common trends are detected, their impact is very limited and therefore emerging equity markets offer benefits in terms of diversification, even in the long run.