Evolution of international stock and bond market integration: Influence of the European Monetary Union

Abstract

This paper examines the dynamic relationship between daily stock and government bond returns of selected countries over the past decade to infer the state and progress of interfinancial market integration. We proceed to empirically investigate the influence of the European Monetary Union (EMU) on time-variations in inter-stock-bond market integration/segmentation dynamics using a two-step procedure. First, we document the downward trends in time-varying conditional correlations between stock and bond market returns in European countries, Japan and the US. Second, we investigate the causality and determinants of this interdependent relationship, in particular, whether the various macroeconomic convergence criteria associated with the EMU have played a significant role. We find that real economic integration and the reduction in currency risk have generally had the desired effect on financial integration but monetary policy integration may have created uncertain investor sentiments on the economic future of the European monetary union, thereby stimulating a flight to quality phenomenon. JEL Classification: C32; E44; F3; G14; G15

Comovements of Financial Markets in the EU countries

“…The authors find a strong connection between stocks and bonds during crash-rebound episodes: immediately after the crash investors sell their risky bonds, and after the rebound they sell some of their safest bonds (usually government) to buy back the risky ones. Kim et al, (2006) continued a previous study of Connolly et al, (2005) who found that the future stockbond correlation at higher daily frequency decreases with increasing stock market uncertainty, concluding that this is influenced by the flight-to-quality phenomenon. The authors also found that stock-bond market integration moved to zero and even negative mean levels in most countries, consistently with flight-to-quality.…”

“…The preferred maturity is 10 years: according to (Baur & Lucey, 2006), long term government bonds should be selected over short term government bonds because they can be considered as closer maturity substitutes to stocks and monetary policy operations are more likely to have an unclear influence on short-term rather than on long-term government bonds. The same opinion is held by (Kim et al, 2006). (Li, 2002;Andersson et al, 2004) and other authors use 10 year government bond indices as the most appropriate for comparison with stocks.…”

“…According to modern investment theory each investment is measured by its profitability and risk, and the possibilities of each investment being intercorrelated are analyzed in their interaction -portfolio (Rutkauskas & Stankeviciene, 2003). Recently some of the authors started questioning the separation between financial markets of different asset classes and offering models for explanation of the connections between them (Bekaert & Grenadier, 2001;Kim et al, 2006;Jang et al, 2008). With globalization and free flow of capital, developed markets became highly integrated into the world market and correlations across different countries have increased (Brennan et al, 2011).…”

“…Multiple authors tried to answer this question (Li, 2002;Ilmanen, 2003;Kim et al, 2006;Baur & Lucey, 2008;Yang et al, 2009;Baele et al, 2009) and came up with evaluation of comovements between different asset class indices in major financial markets. These evaluations were mainly made in order to enlighten the construction of optimum portfolio.…”

Does the digital divide across countries lead to convergence? New international evidence

“…The studies that connect the convergence literature to non-economic growth indicators, such as health expenditures, financial markets and tourism, were performed by Brada et al (2005); Kim et al (2005Kim et al ( , 2006; Narayan (2007);Fung (2009);Eun and Lee (2010); Su et al (2010); Narayan et al (2011) andPark et al (2015).…”