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Cointegration of Indian Stock Markets With Other Leading Stock Markets
Cointegration of Indian Stock Markets With Other Leading Stock Markets
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Cointegration
Cointegration of Indian stock of Indian
markets with other leading stock markets
stock markets
87
N. Rajiv Menon
IMT Department, Yanbu Industrial College, Yanbu, Saudi Arabia
M.V. Subha
Anna University, Coimbatore, India, and
S. Sagaran
Yanbu Industrial College, Yanbu, Saudi Arabia
Abstract
Purpose – One of the anxieties of stock market investors is whether the markets operate efficiently,
independently and with sound fundamentals. This concern is also held by academics and practitioners
for quite some time. However, real market situation tends to exhibit a link as is evident from recent
market movements across the world. The purpose of this paper is to examine whether the stock
markets in the Indian subcontinent have any link with the major stock markets from China, Singapore,
America, and Hong Kong.
Design/methodology/approach – The paper uses Engle Granger test of cointegration.
Findings – The paper finds that the Indian markets are related to some of the markets around the world.
Originality/value – The paper offers insight into the cointegration of Indian stock markets with
other leading stock markets.
Keywords Stock markets, India
Paper type Research paper
Introduction
The revolution in Information Technology coupled with the permeation of high-speed
Internet connectivity have created a fast track information superhighway with global
reach. The technology permeation is taking place at incredible speeds and is highly
democratized so that information is available to any one at any place at any time at low
cost. Capital markets thrive on information, and the information revolution has
transformed these markets world over. Investors can now keep track of the movements
of the capital market on real-time basis and they react to the flow of information from
around the world. These dealings sometimes surge into huge waves of panic actions
and reactions affecting global markets one by one. National economies are no longer
insulated and the repercussions of international events influence the movement of
shares and other investments. With globalization taking roots; investors, governments
and institutions are concerned about the visible linking of geographically separated
markets, though a perfect link is far beyond reality.
Due to the time difference, the financial centers and markets do not close at the same Studies in Economics and Finance
Vol. 26 No. 2, 2009
time. When one market closes, another market on another part of the globe opens. The pp. 87-94
opening markets are aware of the closing prices in the closed markets. The Shanghai q Emerald Group Publishing Limited
1086-7376
and Bombay markets open with the index information from Dow Jones and DOI 10.1108/10867370910963028
SEF the NASDAQ. The efficient market hypothesis suggests that these processes should
26,2 resemble random walks with uncorrelated increments. Latest global events of late
seems to point in this direction such as the events of 27th February 2007 where the
SSE’s (Shangai Market) worst day of trading in 10 years where the SSE Composite
Index fell nearly 9 percent on fears of capital controls, dragging other markets along
throughout the world. Every move by the Federal Reserve cascades throughout
88 financial markets across the world.
Many researches have been conducted and currently been undertaken to study the
various behavioral aspects of capital market in India and beyond. Many studies were
carried out to test the cointegration and interdependencies among various Capital
Markets (Bala and Mukund, 2001; Wong et al., 2004; David, 1994; Chan et al., 1997;
Kanas, 1998; Masih and Masih, 2001). Various researchers have attempted to test the
efficiency and co integration of the Indian Capital Market from time to time. This study
looks at the co integration characteristics of the Indian Capital Market with global
markets using the Engle Granger test of co integration, in the post-liberalization period.
Due to the number of markets and the volume of trade, any number of researches
undertaken is not sufficient to explain the behavior. This study examines the possible
link; the Indian capital market has with other capital markets of the world.
90 Research methodology
Data and sources of data
The share index data is obtained from the NSE NIFTY index along with other major
stock indices from China, Singapore, America, and Hong Kong. The study covers a
time span of ten years; from April 1997 to May 2007.
The two important equity share prices indices in India are:
(1) The BSE Index.
(2) The NSE Index.
These index values are quoted and published on a daily basis at the end of each trading
day. The broad based NSE-NIFTY index values are used for the study. To compare
Indian stock market movements with other global markets, stock index values of
popular markets such as the SEC (China), NASDAQ (America), Hang Seng (HSI, Hong
Kong), STI (Singapore) are used.
Period of study
The period of study is ten years, from April 1, 1997 to May 10, 2007. Similarly the
closing index values of various international stock markets are also collected for the
same period (April 1, 1997-May 10, 2007). The daily Index values from the various
markets are used. No adjustments are made for non-trading days and when the stock
exchange is closed for holidays.
Analysis of data
The theory of cointegration is used to study the interdependence between the National
Stock Exchange (NSE), SEC (China), NASDAQ (America), HSI (Hong Kong) and STI
(Singapore). The Engle Granger test is used to test the cointegration among these indices.
Test of cointegration
The Engle Granger test of cointegration is used to test the cointegration between
NSE-NASDAQ, NSE-HSI, NSE-STI and NSE-SSE. The idea of cointegrated
multivariate time series was introduced by Granger (1981) and developed by Engle
and Granger (1987). Two variables are said to be cointegrated when a linear
combination of the two variables is stationary implying that there is a long term
relationship existing between them. Lack of cointegration suggests that no such
relationship exists. Non stationary univariate time series can be made stationary by
applying the differencing operator delta, repeatedly to the series. In order to test the
cointegration between the NSE and other global stock indices the following hypothesis
(H0 – Null Hypothesis; H1 – Alternate Hypothesis) are formulated:
H0. There is no linear dependence between the indices of the NSE-NASDAQ stock
exchanges.
H1. There is linear dependence between the indices of the NSE-NASDAQ stock Cointegration
exchanges. of Indian
H0. There is no linear dependence between the indices of the NSE-HSI stock stock markets
exchanges
H1. There is linear dependence between the indices of the NSE-HSI Stock
Exchanges. 91
H0. There is no linear dependence between the indices of the NSE-SSE Stock
Exchanges.
H1. There is linear dependence between the indices of the NSE-SSE Stock
Exchanges.
H0. There is no linear dependence between the indices of the NSE-STI Stock
Exchanges.
H1. There is linear dependence between the indices of the NSE-STI Stock
Exchanges.
Testing for co integration involves testing the residuals (the difference between actual
value of the dependent value and the predicted value from the estimated equation) from
an Ordinary Least Square regression for the time series and the residuals are obtained:
Y t ¼ b0 þ b1 xt þ b2 zt þ 1 ð1Þ
Regress y on x and z. The residuals are obtained from the Ordinary least square and a
Dicky Fuller unit root test2 is carried out to check for unit root. If a unit root is not
present, the residuals are stationary and the variables are cointegrated.
The first difference of the residuals DYt is regressed against the first lag of the
residual Yt2 1 and sufficient lags of Yt:
DY t ¼ ðY t 2 Y t21 Þ ¼ ut ð2Þ
The results of the unit root test, t-statistics have to be compared with specially
calculated critical values. If the estimated jtj exceeds any of these critical values the
null hypothesis that there is no cointegration among the variables can be rejected.
Otherwise, the null hypothesis is to be accepted.
Conclusion
The study examined the extent of cointegration between the Indian stock market and
other leading stock markets using the NSE Nifty index along with other major stock
indices of US, China, Singapore and Hong Kong. The study covers a period of ten years;
1% 5% 10%
X Standard Test t-statistic EG critical EG critical EG critical
Index variable error CR DF value value value
References
Bala, A. and Mukund, K.S. (2001), “Interrelationship between Indian and US stock markets”,
Journal of Management Research, Vol. 1 No. 3, pp. 141-8.
Chan, C.K., Benton, G.E. and Min, S.P. (1997), “International stock market efficiency and
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David, W. (1994), “A cointegration rank test of market linkages with an application to the US
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Wong, W.K., Agarwal, A. and Du, J. (2004), “Financial integration for Indian stock market:
a fractional co-integration approach”, Finance India, Vol. XVIII No. 4, pp. 1581-604.
Further reading
Azizjon, A.A., Chakroborty, D., Raymond, A.K.C. and Jain, A.K. (2004), “The random walk
hypothesis on the Bombay Stock Exchange”, Finance India, Vol. XVIII No. 3, pp. 1251-8.
Dickey, A.D. and Fuller, A.W. (1981), “Likelihood ratio statistics for autoregressive time series
with a unit root”, Econometrica, Vol. 49 No. 4, pp. 1057-72.
Engle, R.F. and Yoo, B.S. (1987), “Forecasting and testing in co-integrated systems”,
Journal of Econometrics, Vol. 35, pp. 143-59.
Monder, C. (2002), “Asymmetry in the EMS: new results from a cointegration analysis”,
Finance India, Vol. XVI No. 2, pp. 573-84.
SEF Samanta, G.P. and Sanjib, B. (2005), “Predicting stock market – ‘an application of artificial
neural network technique through genetic algorithm’”, Finance India, Vol. XIX No. 1,
26,2 pp. 173-88.
Schleifer, A. (2000), Inefficient Markets: An Introduction to Behavioral Finance, Oxford
University Press, Oxford.
Sharma, J.L. and Robert, E.K. (1977), “A comparative analysis of stock price behaviour on the
94 Bombay, London and New York stock exchanges”, Journal of Financial and Quantitative
Analysis, September, pp. 391-413.