Contagion Effect Between Bombay Stock Exchange (BSE), National Stock Exchange (NSE) and Nasdaq

Abstract

This comprehensive study investigates the contagion effect and relationships among three major stock exchanges—specifically, the two largest stock exchanges in India, BSE (Bombay Stock Exchange) and NSE (National Stock Exchange), and the globally renowned NASDAQ—spanning an extensive eight-year period on a daily basis. Employing a robust analytical framework in E-views, the study conducts a suite of tests, including Unit Root tests, Granger causality analysis, Johansen's Cointegration test, Vector Error Correction Models (VECM), and Dynamic Ordinary Least Squares (DOLS). The results of our investigation reveal a significant cointegration among BSE, NSE, and NASDAQ, indicating a long-term relationship between these stock exchanges. Notably, the study establishes that BSE Granger causes NSE, given their shared national context. Moreover, in an international context, NASDAQ emerges as a Granger cause for both BSE and NSE, while NSE Granger causes NASDAQ. This nuanced understanding of Granger causality relationships has profound implications for investors seeking to optimize their portfolios. Importantly, our findings suggest a viable strategy for portfolio diversification, emphasizing the potential benefits of allocating investments across stock exchanges with limited correlation. Specifically, investors can strategically diversify their portfolios by considering exchanges that do not exhibit Granger causality relationships with each other. This insight provides a practical guide for investors looking to capitalize on opportunities in markets with distinct and uncorrelated movements, thereby enhancing the effectiveness of international portfolio diversification. In essence, this study underscores the feasibility of diversification between exchanges with no observed Granger causality relationships, shedding light on the nuanced dynamics of inter-market dependencies. Investors can leverage these findings to make informed decisions, mitigating risks, and capitalizing on diverse opportunities across global financial markets.