Cross-border relationships? : A Quantitative study of stock exchange correlation within the European Monetary Union

Abstract: AbstractDevelopment of shareholder own companies and the stock exchanges has led to the situation where investors, both individual and institutional, can invest in shares of companies in terms of seeking profit. Therefore the investors as the speculators of the market share a need for accurate information to base their investment decisions upon. Different measures has been developed to follow the stockexchanges to be able sufficiently track the performance of markets. One of the possible measures developed is stock exchange indexes. Countries within the European Monetary Union (EMU) share a common currency, resulting to a possibility to invest within these 16 EMU-countries without the presence of the fluctuating exchange rates risk. Thesis will concentrate on the stock exchange correlation within European Monetary Union. The correlation is measured over the four year period from May 2005 to April 2009. The performances of each individual stock exchange are tracked in terms of country specific stock exchange indexes. The basis of this thesis is the dilemma of Modern Portfolio Theory (MPT) about the diversification and risk reduction. The main idea of the MPT presented by Markowitz (1959) is that; the investor can reduce the risk of the investments by investing to products which are less correlated. The purpose is therefore to generate a study about the correlation within the Monetary Union and apply it to the diversification possibilities within the EMU. The data is collected from each stock exchange by tracking the daily closing values of the indexes over the 4 year period (May 2005-April 2009). Data is progressed by plotting the values to SPSS to receive the correlation and the empirical findings. These findings are contrasted to the relevant theories to be able to receive a sufficient conclusion about the diversification possibilities. The results of the thesis will present a positive correlation between the countries within the EMU. However, the correlation between countries differs and fluctuates. There is evidence that lower correlation exists between the older (12 member countries) and the newer member states (4 countries) of the European Monetary Union. Similar situation exists also in case of Ireland. The fluctuation of the correlation, on the other hand, can be found many cases for the year 2007. Indicating lower correlation for the period of the year 2007. The yearly correlation in terms of the new member countries is fluctuating over the whole period from 2005 to 2009. Suggesting yearly differences in terms of risk reduction. The conclusion of the study is that the possibilities to diversify the portfolios within the EMU exist. However, the level of diversification possibilities differs. There are countries with extremely strong correlation indicating that the diversification in terms of these countries can be difficult and the benefits of reducing risk can be minimal. On the other hand, the existing fluctuation presented implicates that the possibilities can differ also in terms of different periods.