Global market place and causality

Abstract

Financial markets in recent years have become linked as never before due to the development of low-cost computer and communication technology and the deregulations which have led to the lessening of the frictions and barriers to international capital flows. Trading takes place continuously around the clock due to telephone and satellite links, and we are moving very fast toward the integration of the world markets. The investor in the stock market has truly become global. For example, pension funds have been investing record sums in foreign stocks-an estimated $120 billion in 1992 as compared to only $10 billion in 1977. Deregulation and restructuring have made the world capital markets more liquid and efficient. However, Black Monday provided an early preview that, while the integration of the markets increase the investors’ flexibility and potential for diversification, integration could as well lead to a chain reaction of the markets that could bring the worlds markets down together. There is an axiom of parallelism which indicates that prices in the NYSE, London, etc. normally move in the same direction. But the remaining questions are the following: Does any one of these centers lead the others? Do the leaders get affected equally by the followers? A priori, there exists a high expectation of correlation among these markets. But correlation does not imply causation. Various aspects of linkages between international financial markets have been the subject of several studies since the early 1970s. Relevant to the theme of this papeG the main thrust of these studies may be categorized in the areas of “international” market: