Cointegration and Causality in International Stock Markets: A study of long-run stochastic trends in Oil & Gas and Financials indices
Abstract: As economies around the world grow and become more integrated, it is interesting to investigate how stock markets move in relation to one another. Some activists of the theory of decoupling argue that economies of emerging markets have become so self-sufficient that they have decoupled from the developed markets. The aim of this paper is to investigate whether the decoupling theory holds for market sectors, namely Oil & Gas and Financials, and whether there are any long-term relationships between equities belonging to the same sector but in different countries. The specific countries chosen are Brazil, Russia, India, the US, the UK, and Japan. The relationships are investigated for the period 2000-2009 and the time period is split into two sub-periods. By using the Augmented Engle-Granger test for cointegration it is found that there is more cointegration in the Oil & Gas sector, compared to the Financials sector, and that for both sectors there is less cointegration during the recent financial crisis. The VECM and VAR model are used to investigate the causal relationships among indices in each of the sectors. It is found that, for both sectors, causality increases between time periods (most likely due to volatility contagion), however this increase is larger for the Oil & Gas sector, compared to the Financials sector. The US has a predictive effect on all the studied markets and in both sectors. It is unclear whether Brazil is showing signs of decoupling or is able to price other markets due to its different market opening hours. The Russian Oil & Gas sector is not able to predict any of the other markets (except a weak effect on Japan).
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