Contenidos

One of the most cited articles in international diversification is Grubel‟s (1968) which introduced the benefit of international diversification. He demonstrated that the benefits of international diversification are mathematically correct. Since the work of Grubel (1968) international market linkages has been more effective. There are some studies which have examined integration of the stock markets worldwide; examples, being Agmon (1972), Agmon (1973), Webb et al. (1995) and Kazi (2009).

Agmon (1972) identified two different approaches to the international capital markets to explain the equity market linkages: segmented market approach , and one multinational perfect capital market approach. According to the segmented market approach the capital

markets are separated entities, and they are almost not related to each other. Under the assumption of market segmentation, capital market returns may differ in different national markets. Market segmentation approach has a large following but it is not the only explanation of the international capital markets. The alternative hypothesis is the one multinational perfect capital market approach. It considers world capital markets as an integrated one capital market. The prices of capital assets in the international market behave as if there is one multinational perfect capital market.

The one market hypothesis is consistent with many generally accepted economic theories. It is also consistent with the international APT, which is becoming more popular in the literature. The one market hypothesis is unambiguous where market segmentation can stand for any number of specific imperfect market formations.

It can be argued that market segmentation is the only possible structure of the international capital market. As there are many different currency areas, political groupings and trade blocks. These can be an evidence of the segmented international capital market. However, a close observation of the capital market movements around the world shows that the market is behaving as one global capital market. Agmon (1972) noted, however, that a certain body of data can be consistent with both the one market hypothesis and any one of several specific forms of market segmentation. Agmon (1972) supported the validity of the one market approach for the multinational equity market. The study concludes that markets are reasonably well integrated internationally, but with continuing evidence of mild segmentation and lag/lead relationships between the US and other stock market indices.

Since the late 1970s the survival of economic liberalism has been the dominant factor in world economies. Financial markets have been deregulated, most currencies floated, capital movements have been liberalized, and investments and cross listings of financial assets have been freed up. These phenomena have contributed to the further linkages of the world

financial markets. Moreover, the more recent literature concentrates on the international APT and overseas economic variables on the stock market returns.

A study by Kleiman et al.(2002) documented similar results to Agmon (1972). They employed the Johansen-Juselius co-integration analysis. The study reveals that all three regions‟ markets, Europe, Asia and North America (comprising a total of thirty countries), appear co-integrated and share a common long-run stochastic trend. Results of co-integration analyses and vector error correction models suggest that diversification benefits through international real estate securities which can only be achieved in the short run.

Eun and Shim (1989), investigating the international transmission mechanism of stock market movements, found that there is a significant interaction between national stock markets. The US market movement is clearly affecting the others. However, no single foreign market can significantly affect the U.S. market movements. In a similar paper Dickinson (2000) found that there have been greater links between stock markets in recent years with the US causing other market movements.

The October 1987 stock market crash is a good example of the international stock market linkages. King and Wadhwani (1990) investigated why, in October 1987, almost all stock markets fell together despite all of them being in the different economic regions. They constructed a model in which "contagion" between markets occurs as a result of attempts by rational agents to infer information from price changes in other markets providing a channel through which a "mistake" in one market can be transmitted to other markets. They offer supporting evidence for contagion effects using two different sources of data. The authors examined the linkages between equity markets.

Kortian and O'Reagan (1996) using daily data between 1987 to 1996, examined the behaviour of price movements in the Australian bond market, stock market and foreign exchange markets and international market linkages. The paper did not find any compelling

evidence of the presence of a trend increase over the period. However there is evidence of quite significant cross-country 'contagion' or 'spillover' effects on Australia's bond and equity markets. The predominant foreign market influence appears to be the US on the both bond and stock market. The authors argue that Australian bond and share market volatility is higher in bear markets than in bull markets, and higher following a market fall than a market rise.

A recent Australian study by Kazi (2008) examined the relationship between the Australian stock market and the stock markets of its major trading partners, namely, UK, USA, Canada, Germany, France, and Japan using annual data between 1945 and 2002. This paper applied both ordinary least squares and generalized method of moments. Results of the ordinary least squares indicate that UK, Canada and France stock market returns were significant. Alternatively, the result of generalized method of moments indicates that four market: UK, Canada, France and Germany, were significant. Accordingly, Kazi (2009) concluded that the Australian stock market was related to that of its trading partners; and it was been affected four markets of which the UK is the most significant.

Figure 4.29 shows the relationships between the major international stock market indices. There are relationships but they are not one by one. For example Japan‟s Topix index is going into different directions than the other major indices. As is argued by some authors (Agmon 1972) there is no evidence that the international markets are behaving as one perfect stock market. There is no compelling evidence of a clear trend relationship over the period. This situation supports the contagion theory of King and Wadhwani (1990). There is a clear evidence of 'contagion' or 'spillover' effects on international market indices.

Figure 4.29. International stock market linkages, Mar 60 – Dec 08, (Mar 60 = 100)

. Data source: DX Database