Did Baltic stock markets offer diversification benefits during the recent financial turmoil? Novel evidence from a nonparametric causality in quantiles test

Motivated by financial liberalization investors seek for new investment opportunities through international portfolio diversification. To this end we explore any asymmetric causal relationship between developed European stock markets (German, France and U.K) and emerging Baltic markets namely; Estonia, Latvia and Lithuania. Our analysis focuses on the period before and after countries’ EU accession and pre- and posts the global financial crisis. For this purpose, both the standard parametric test for causality and a novel nonparametric test for causality in quantiles are employed. The results of both the parametric and nonparametric Granger causality test support a causal relationship that runs from all of the major markets to the Baltic markets across both samples. However, the parametric test fails to detect the causal effect from the Baltic markets to most of the major markets in both sample periods. In contrast, the nonparametric Granger Causality test reveals that stock returns in the Baltic markets have significant predictive power for changes in the major stock returns especially during periods of financial turmoil. Policy implications for international investors are also discussed.