Weak Efficiency And Linear Regression Of Central And Eastern European Markets

The deepening of financial integration in the EU has accelerated in the last decade. The expansion of trade relations, intensification of investment flows and capital market development evidence strengthening of financial integration processes. Particularly, the large number of foreign companies listed on domestic equity market enhances financial integration. In this regard, the enlargement of stock markets of Central and Eastern European countries and efficient capital allocation define further integration prospects. The stock market efficiency depends mainly on adequate pricing of capital and risk. The rational investment expectations and information efficiency positively impact trading strategies and eliminates the presence of undervalued and overvalued assets. This leads to the high competitiveness of stock market and decreases the likelihood of abnormal profits. Studies of stock market efficiency of CEE countries and the correlations of CEE capital markets with Western European markets have a significant importance owing to the ongoing financial integration and impact of financial crisis. I run two tests to check the capital market efficiency of CEE countries taking into account the perspectives of CEE countries to enter the euro area. The aim of this quantitative empirical research is twofold: first, it investigates the weak form of market efficiency for the period from 2nd of September 2005 to 31st of August 2011 by using the Augmented Dickey-Fuller and Kwiatkowski-Phillips-Schmidt-Shin unit root procedures. Second, it checks the existence of linear correlation between CEE countries and Western European markets. The results assume that the stock markets of some CEE countries follow a unit root. The linear regression model evidences different correlation patterns between CEE and EU old capital markets. Those findings can be used for deeper investigation of market efficiency by highlighting convergence processes of CEE countries with EU old member states. Also effective capital allocation channels, institutional foundations of markets and strengthening of corporate governance should be highlighted. Finally, the outcomes of my paper will be useful for researchers in the field of finance.