Abstract
This study aims to explore the relationship between market integration, foreign portfolio equity holding and inflation rates on international stock market linkages between Pakistan and India. To measure stock equity interlinkage, we constructed international co-movement index through rolling beta estimation. Market integration variable between these two countries is constructed using the International Capital Asset Pricing Model (ICAPM). To check the impact of market integration, foreign portfolio equity holding and inflation rate on Pakistan-Indian stock market co-movement, we applied autoregressive distributed lag (ARDL) estimation. ARDL estimation is applied due to different stationarity levels of the included variables. The level of convergence speed is measured by the introduction of error correction term (ECT) followed by variance decomposition analysis. Results of the study indicated presence of long term relationship among the included variables along with significance variance in bilateral co-movement due to inflation rate differential. The significance of inflation rate differences between these two countries are in accordance with portfolio balance theory stating that investors possess information about the macroeconomic variables thereby readjusting their portfolios for effective diversification.
Highlights
Co-movement pattern among international stock markets has been an important topic in the field of finance due to its practical implications in allocation of assets and risk management
The purpose of this study is to explore the factors playing important roles in bilateral stock market co-movement between Indian and Pakistani stock markets
This study aims to capture the role of market integration, foreign portfolio equity holding and inflation rate differences on bilateral stock market co-movement
Summary
Co-movement pattern among international stock markets has been an important topic in the field of finance due to its practical implications in allocation of assets and risk management. The initial work of Grubel [1] has gained much importance in the field of international diversification followed by contribution of many past researchers. Many of these studies concluded the presence of an increasing co-movement pattern in developed equity markets since mid 1990s. The formulation of a well-diversified portfolio depends on bilateral equity co-movement and financial integration among the associated markets and on some interlinked processes. These interlinked processes affect these underlying co-movements and, in some cases, are affected by them and serve as a catalyst for triggering and transmitting these return co-movements. In the present study, we have included two Asian equity markets from different level of market efficiency, i.e., Pakistani market among the frontier level and Indian equity market from the emerging level
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