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The Evolution of Equity Market Integration on Sectoral Level: A time-varying approach to analyzing the impact of EMU

Elfving, Ralf LU (2011) NEKM03 20111
Department of Economics
Abstract
This thesis analyzes the evolution of integration between equity markets based on a market index and six sector indices for four countries that adopted the EMU in 1999 as well as two countries that did not. The purpose is twofold; first to identify if the integration has increased and secondly try to determine if the EMU has played a part. The estimation window is set to January 1987 to December 2010 with daily frequency. The methods used are Johansen cointegration analysis and principal component analysis. To capture the time-variability in the integration that has been identified by previous research a rolling- window technique is deployed. By estimating the methods over an event window of 1000 observations and rolling it forward one... (More)
This thesis analyzes the evolution of integration between equity markets based on a market index and six sector indices for four countries that adopted the EMU in 1999 as well as two countries that did not. The purpose is twofold; first to identify if the integration has increased and secondly try to determine if the EMU has played a part. The estimation window is set to January 1987 to December 2010 with daily frequency. The methods used are Johansen cointegration analysis and principal component analysis. To capture the time-variability in the integration that has been identified by previous research a rolling- window technique is deployed. By estimating the methods over an event window of 1000 observations and rolling it forward one observation at a time while dropping one observation, keeping the window constant at 1000 observations, time-series of estimated results are generated. By plotting these the evolution of the estimates are presented and interpreted. Although the body of previous research is vast the author has not been able to find a study that utilize sectoral data and rolling-window techniques meaning that the results could potentially contribute with unique findings.

The results and the subsequent interpretations from the two methods differ and are inconsistent. The Johansen cointegration method show little evidence of prolonged periods of significant cointegration or trends towards increased cointegration, even after the intensified stages of the EMU in the end of the 1990s. This is interpreted as if the EMU has had little impact on the market integration on the broader market index as well as the individual sectors for the four EMU adopters. It also shows that there still exists diversification opportunities for portfolio investors. The principal component analysis on the other hand show that the level of and convergence in participation of the first dominant component has increased since 1996 for the market index and most sectors, as has the explanatory power of the first component. The explanatory power is however largest for the market index and for financials indicating a lower degree of integration in other industries. The two non-EMU member countries to a large extent share the level of participation in the first component meaning that role of EMU in the integration process is further questioned, although it’s possible the findings could be explained by spill-over effects also to non-EMU countries. (Less)
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author
Elfving, Ralf LU
supervisor
organization
course
NEKM03 20111
year
type
H1 - Master's Degree (One Year)
subject
keywords
Integration, Cointegration, Time-varying Integration, Principal Component Analysis, Rolling windows, Sectoral Equity Indices, EMU
language
English
id
2172080
date added to LUP
2011-10-06 07:55:09
date last changed
2011-10-06 07:55:09
@misc{2172080,
  abstract     = {This thesis analyzes the evolution of integration between equity markets based on a market index and six sector indices for four countries that adopted the EMU in 1999 as well as two countries that did not. The purpose is twofold; first to identify if the integration has increased and secondly try to determine if the EMU has played a part. The estimation window is set to January 1987 to December 2010 with daily frequency. The methods used are Johansen cointegration analysis and principal component analysis. To capture the time-variability in the integration that has been identified by previous research a rolling- window technique is deployed. By estimating the methods over an event window of 1000 observations and rolling it forward one observation at a time while dropping one observation, keeping the window constant at 1000 observations, time-series of estimated results are generated. By plotting these the evolution of the estimates are presented and interpreted. Although the body of previous research is vast the author has not been able to find a study that utilize sectoral data and rolling-window techniques meaning that the results could potentially contribute with unique findings.

The results and the subsequent interpretations from the two methods differ and are inconsistent. The Johansen cointegration method show little evidence of prolonged periods of significant cointegration or trends towards increased cointegration, even after the intensified stages of the EMU in the end of the 1990s. This is interpreted as if the EMU has had little impact on the market integration on the broader market index as well as the individual sectors for the four EMU adopters. It also shows that there still exists diversification opportunities for portfolio investors. The principal component analysis on the other hand show that the level of and convergence in participation of the first dominant component has increased since 1996 for the market index and most sectors, as has the explanatory power of the first component. The explanatory power is however largest for the market index and for financials indicating a lower degree of integration in other industries. The two non-EMU member countries to a large extent share the level of participation in the first component meaning that role of EMU in the integration process is further questioned, although it’s possible the findings could be explained by spill-over effects also to non-EMU countries.},
  author       = {Elfving, Ralf},
  keyword      = {Integration,Cointegration,Time-varying Integration,Principal Component Analysis,Rolling windows,Sectoral Equity Indices,EMU},
  language     = {eng},
  note         = {Student Paper},
  title        = {The Evolution of Equity Market Integration on Sectoral Level: A time-varying approach to analyzing the impact of EMU},
  year         = {2011},
}