This paper examines the integration of financial markets using data from the Dubai Financial Market Stock Exchange, Abu Dhabi Stock Exchange and the FTSE Nasdaq Dubai UAE 20 index. To do this, we apply a vector error correction model and a permanent-transitory decomposition of the series of prices. Our results reveal the existence of a long-run equilibrium relationship between the three financial indices suggesting that UAE stock markets are integrated. Shocks to any of these markets affect the other markets in the long and the short run through the equilibrium condition. We uncover a major role of the FTSE Nasdaq Dubai UAE 20 index in this equilibrium relationship. Our analysis of market integration also allows us to obtain a permanent-transitory decomposition given by two common factors that drive the three financial indices. Whereas the first factor is defined as a weighted combination of the two major financial indices the second factor is mainly determined by the FTSE Nasdaq Dubai. As a byproduct of our analysis, we find empirical evidence of short-run and long-run predictability running from the Dubai financial indices to the Abu Dhabi index.

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