An examination of financial integration for the group of seven (G7) industrialized countries using an I() cointegration model

Abstract

This study investigates financial cointegration of G7 equity markets. The term ‘international stock market integration’ refers to an area of research in financial economics that covers many different aspects of the interrelationships across equity markets. The cointegration of order two model, I(Equation2), that was developed by Johansen is used to specify potential cointegration structure. The empirical validity of this economic model is investigated by employing monthly stock indexes of the Group of Seven (G7) from March 1978 through December 1997 on Morgan Stanley's Capital International (MSCI) indices. This monthly time series data is used to estimate the vector error correction model of order two (VECM(Equation2)). The joint cointegration tests show that (at p<0.05) there is one common I(Equation2) trend and two I(Equation1) trends in the financial equity market returns of G7 countries. Potential explanations of these results and implications for portfolio diversification strategies are discussed.

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