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Term structure of return correlations and international diversification: evidence from European stock markets

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  • Ming-Shiun Pan
  • Y. Angela Liu
  • Herbert Roth
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    Abstract

    The paper examines the term structure of correlations of weekly returns for the stock market in the US, Japan and nine European countries between 1988 and 1994. Stock indices are decomposed into permanent and temporary components using a canonical correlation analysis and then short- and long-horizon return correlations are calculated from these two price components. The empirical results reveal that the relationships of return correlations among these stock markets are not stable across return horizons. While correlations, in general, tend to increase with return horizons, there are several cases showing that correlations decline when investment horizons increase.

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    File URL: http://www.tandfonline.com/doi/abs/10.1080/13518470122843
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    Bibliographic Info

    Article provided by Taylor & Francis Journals in its journal The European Journal of Finance.

    Volume (Year): 7 (2001)
    Issue (Month): 2 ()
    Pages: 144-164

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    Handle: RePEc:taf:eurjfi:v:7:y:2001:i:2:p:144-164

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    Related research

    Keywords: Stock Markets Weekly Returns Term Structure Correlation Analysis Short Horizon Long Horizon;

    References

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    1. Fama, Eugene F & French, Kenneth R, 1988. "Permanent and Temporary Components of Stock Prices," Journal of Political Economy, University of Chicago Press, vol. 96(2), pages 246-73, April.
    2. Mervyn King & Enrique Sentana & Sushil Wadhwani, 1990. "Volatiltiy and Links Between National Stock Markets," NBER Working Papers 3357, National Bureau of Economic Research, Inc.
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    7. Johansen, Soren, 1991. "Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian Vector Autoregressive Models," Econometrica, Econometric Society, vol. 59(6), pages 1551-80, November.
    8. Gultekin, Mustafa N & Gultekin, N Bulent & Penati, Alessandro, 1989. " Capital Controls and International Capital Market Segmentation: The Evidence from the Japanese and American Stock Markets," Journal of Finance, American Finance Association, vol. 44(4), pages 849-69, September.
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    10. Heston, Steven L. & Rouwenhorst, K. Geert, 1994. "Does industrial structure explain the benefits of international diversification?," Journal of Financial Economics, Elsevier, vol. 36(1), pages 3-27, August.
    11. Cho, D Chinhyung & Eun, Cheol S & Senbet, Lemma W, 1986. " International Arbitrage Pricing Theory: An Empirical Investigation," Journal of Finance, American Finance Association, vol. 41(2), pages 313-29, June.
    12. Panton, Don B. & Lessig, V. Parker & Joy, O. Maurice, 1976. "Comovement of International Equity Markets: A Taxonomic Approach," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 11(03), pages 415-432, September.
    13. George M. von Furstenberg & Bang Nam Jeon, 1989. "International Stock Price Movements: Links and Messages," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 20(1), pages 125-180.
    14. Engle, Robert F & Susmel, Raul, 1993. "Common Volatility in International Equity Markets," Journal of Business & Economic Statistics, American Statistical Association, vol. 11(2), pages 167-76, April.
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