Why Do Financial Markets Move Together?: An Investigation of Greek and Turkish Markets

This paper investigates which theory--crisis- or noncrisis-contingent theory-- may better explain the comovements observed between Turkish and Greek financial market returns. Using cointegration and vector error-correction models, we first establish interdependence and a long-run causal relationship between stock and foreign exchange markets. Then, using the crisis- and noncrisis-contingent theories to explain the observed linkage, we show that the comovement of the stock markets across the two countries can be primarily attributed to the sharing of similar trading and foreign direct investment partners, providing evidence for the noncrisis-contingent theory in this case. On the other hand, evidence indicates that the recent Asian and Russian crises have produced significant contagion effects between the Greek drachma and Turkish lira markets, but not between Greek and Turkish stock markets, suggesting that the crisis-contingent models may better explain the linkage between the exchange markets. The policy implications of our findings for Turkey's European Union-membership efforts, as well as for market practitioners and international investors, are discussed.