Does Economic Integration Affect the Co-movement between Financial Markets? Evidence from Pakistani equity market with its global partners

Ahmad Fraz,Arshad Hassan,Sumayya Chughtai

doi:10.34260/jaebs.436

Abstract

The study investigates the impact of bilateral trade, economic fundamentals and financial crisis on the equity market integration (EMI) of Pakistan’s equity market with its major global trading partners (China, India, USA and UK) for the period 1998 to 2016. The findings of the study indicate that bilateral trade and economic conditions have a significant impact on EMI, the export dependence of two economies may increase the EMI and import dependence reduces the EMI of two economies. Moreover, inflation differential and volatility in the bilateral exchange rate have a negative impact on EMI. It implies that inflation rates in Pakistan’s equity market are higher as compare to other markets and volatility in bilateral exchange rate may reduce trade flows and its tendency to follow other market (Bracker, Docking , & Koch, 1999). Furthermore, the financial crisis in an economy may reduce the EMI with its trading partners and EMI between different markets is affected by their bilateral economic fundamentals. The results imply that financial integration between different markets is affected by their bilateral economic fundamentals. The study has strong implications for international investors who need to assess risks and benefits associated with international portfolio diversification.

Highlights

The study examines the impact of economic variables on equity market integration (EMI) of Pakistani equity market with two developed market and two regional emerging markets (India and China) for the period of 1998 to 2016
The study employs two-step procedures, in the first step the co-movement of equity markets is estimated by using the multifactor model, and in the second step the impact of economic variables on EMI is investigated
The results of co-movement indicate that bilateral EMI of the Pakistani equity market and the UK market is higher as compared to the other countries and the highest value of R2 0.278 is observed in 2007.In the second step, the study examines the impact of economic fundamentals on EMI

Summary

Introduction

The current study is an attempt to explore the bilateral macroeconomic factors that explains the co-movement between different equity markets. Most of the work in this domain has been done in the USA (Johnson & Soenen, 2002; Tai, 2007; Dimitriou & Simos , 2014) but in recent past the emerging markets have grabbed the attention of the researchers due to their growing importance (Wang & Moore, 2008; Simpson, 2008; Karagoz & Ergun, 2010; Peiro, 2016; Paramati et al, 2018). Recent work does not focus on determining the economic factors behind co-movement of equity markets and a few studies have been conducted to explore different macroeconomic forces that impact EMI of developed and emerging markets i.e. Recent work does not focus on determining the economic factors behind co-movement of equity markets and a few studies have been conducted to explore different macroeconomic forces that impact EMI of developed and emerging markets i.e. Robert and Soenen (2003) explore the impact of trading relations on co-movement between South American markets and the USA

Methods

Results

Conclusion