A Study of the Excess Comovement on the Swedish Stock Market 1985-2003

Abstract: This paper is focused on two phenomenons that is called excess comovement and financial contagion. The excess comovement is defined as the comovement, or correlation, between normally uncorrelated assets, that can not be explained by economic fundamentals and financial contagion is the occurrence of excess comovement. Excess comovement has been observed on several stock markets by economic researchers in different countries and the purpose with this paper is to see if these phenomenons have been present on the Swedish stock market during the studied time span 1985-2003. Nine Swedish industry indexes have been used and as economic fundamentals six explanatory variables has been chosen, both American and Swedish. The method used is a linear multifactor model and the OLS residuals are used in the two measures for a mean of excess comovement and the financial contagion. The results are statistically significant and show that there is indeed excess comovement present on the Swedish stock market during the studied time span. It is difficult to explain why there is excess comovement on the Swedish market, but probably there are psychological factors affecting the investors to behave irrational. The knowledge of the existence of excess comovement on a stock market is important for anyone investing in the market since excess comovement can lead to difficulties of finding the desired risk profile of the portfolio.