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Testing for Convergence in Stock Markets: A Non-Linear Factor Approach

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  • Guglielmo Maria Caporale
  • Burcu Erdogan
  • Vladimir Kuzin
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    Abstract

    This paper applies the Phillips and Sul (2007) method to test for convergence in stock returns to an extensive dataset including monthly stock price indices for five EU countries (Germany, France, the Netherlands, Ireland and the UK) as well as the US over the period 1973-2008. We carry out the analysis on both sectors and individual industries within sectors. As a first step, we use the Stock and Watson (1998) procedure to filter the data in order to extract the long-run component of the series; then, following Phillips and Sul (2007), we estimate the relative transition parameters. In the case of sectoral indices we find convergence in the middle of the sample period, followed by divergence, and detect four (two large and two small) clusters. The analysis at a disaggregate, industry level again points to convergence in the middle of the sample, and subsequent divergence, but a much larger number of clusters is now found. Splitting the cross-section into two subgroups including Euro area countries, the UK and the US respectively, provides evidence of a global convergence/divergence process not obviously influenced by EU policies.

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    File URL: http://www.cesifo-group.de/portal/page/portal/DocBase_Content/WP/WP-CESifo_Working_Papers/wp-cesifo-2009/wp-cesifo-2009-11/cesifo1_wp2845.pdf
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    Bibliographic Info

    Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 2845.

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    Date of creation: 2009
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    Handle: RePEc:ces:ceswps:_2845

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    Related research

    Keywords: stock market; financial integration; European Monetary Union convergence; factor model;

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    References

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    1. Steven N. Durlauf & Danny T. Quah, 1998. "The New Empirics of Economic Growth," Working Papers, Santa Fe Institute 98-01-012, Santa Fe Institute.
    2. Peter C.B. Phillips & Donggyu Sul, 2007. "Transition Modeling and Econometric Convergence Tests," Cowles Foundation Discussion Papers, Cowles Foundation for Research in Economics, Yale University 1595, Cowles Foundation for Research in Economics, Yale University.
    3. Bernard, A.B. & Durlauf, S.N., 1994. "Interpreting Tests of the Convergence Hypothesis," Working papers, Wisconsin Madison - Social Systems 9401r, Wisconsin Madison - Social Systems.
    4. Campa, Jose Manuel & Fernandes, Nuno, 2006. "Sources of gains from international portfolio diversification," Journal of Empirical Finance, Elsevier, Elsevier, vol. 13(4-5), pages 417-443, October.
    5. William N. Goetzmann & Lingfeng Li & K. Geert Rouwenhorst, 2001. "Long-Term Global Market Correlations," NBER Working Papers 8612, National Bureau of Economic Research, Inc.
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    7. Hardouvelis, Gikas A. & Malliaropulos, Dimitrios & Priestley, Richard, 2007. "The impact of EMU on the equity cost of capital," Journal of International Money and Finance, Elsevier, Elsevier, vol. 26(2), pages 305-327, March.
    8. Kpate ADJAOUTÉ & Jean-Pierre DANTHINE, 2003. "European Financial Integration and Equity Returns: A Theory-Based Assessment," FAME Research Paper Series, International Center for Financial Asset Management and Engineering rp84, International Center for Financial Asset Management and Engineering.
    9. Bart Hobijn & Philip Hans Franses, 2000. "Asymptotically perfect and relative convergence of productivity," Journal of Applied Econometrics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 15(1), pages 59-81.
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    12. Adjaoute, Kpate & Danthine, Jean-Pierre, 2001. "EMU and Portfolio Diversification Opportunities," CEPR Discussion Papers, C.E.P.R. Discussion Papers 2962, C.E.P.R. Discussion Papers.
    13. Nazrul Islam, 2003. "What have We Learnt from the Convergence Debate?," Journal of Economic Surveys, Wiley Blackwell, Wiley Blackwell, vol. 17(3), pages 309-362, 07.
    14. Ulrich Fritsche & Vladimir Kuzin, 2008. "Analysing Convergence in Europe Using a Non-linear Single Factor Model," Macroeconomics and Finance Series, Hamburg University, Department Wirtschaft und Politik 200802, Hamburg University, Department Wirtschaft und Politik.
    15. Barro, Robert J & Sala-i-Martin, Xavier, 1992. "Convergence," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 100(2), pages 223-51, April.
    16. Heston, Steven L. & Rouwenhorst, K. Geert, 1994. "Does industrial structure explain the benefits of international diversification?," Journal of Financial Economics, Elsevier, Elsevier, vol. 36(1), pages 3-27, August.
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    Cited by:
    1. Rughoo, Aarti & Sarantis, Nicholas, 2014. "The global financial crisis and integration in European retail banking," Journal of Banking & Finance, Elsevier, Elsevier, vol. 40(C), pages 28-41.
    2. Rughoo, Aarti & Sarantis, Nicholas, 2012. "Integration in European retail banking: Evidence from savings and lending rates to non-financial corporations," Journal of International Financial Markets, Institutions and Money, Elsevier, Elsevier, vol. 22(5), pages 1307-1327.
    3. Nicholas Apergis & Christina Christou & James Payne, 2011. "Political and Institutional Factors in the Convergence of International Equity Markets: Evidence from the Club Convergence and Clustering Procedure," Atlantic Economic Journal, International Atlantic Economic Society, International Atlantic Economic Society, vol. 39(1), pages 7-18, March.

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