DP6519 Economic Integration and the Co-movement of Stock Returns

Author(s): Pedro Morgado, José Tavares
Publication Date: October 2007
Keyword(s): Bilateral Trade Intensity, Co-movement of Stock Returns, Economic Integration, Real Exchange Rate Volatility
JEL(s): E44, F15, F36, G15
Programme Areas: International Macroeconomics, Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=6519

In this paper we analyze the determinants of co-movements in stock returns among 40 developed and emerging markets, from the 1970s to the 1990s. We provide empirical estimates of the impact of bilateral indicators of economic integration such as bilateral trade intensity, the dissimilarity of export structures, the asymmetry of output growth and bilateral real exchange rate volatility. We find that each indicator has the expected effect on the correlation of stock returns: trade intensity increases the correlation of stock returns, while real exchange rate volatility, the asymmetry of output growth and the degree of export dissimilarity decrease it. We also find that countries with more developed and more analogous institutions - in terms of either rule of law or civil liberties - display a higher correlation of stock returns.