Stock market integration and macroeconomic fundamentals: an empirical analysis, 1980-95

Abstract

As stock markets world-wide have become more open there has been increasing interest in international linkages. The recent literature has used modern time series techniques (cointegration, causality) to investigate this issue and generally has found there to be greater links between stock markets in recent years with the US causing other market movements. In a different vein, there has been work to identify the underlying economic variables which cause stock index movements. This research has uncovered a number of key macroeconomic variables (e.g. output, inflation, interest rates) as significant determinants of stock market movements. This paper approaches the issue of stock index behaviour by combining the insights of both these approaches. In particular it considers the extent to which correlations between international stock markets are a result of globalization of financial markets or whether they reflect the increasingly integrated nature of the world real economy, as represented by comovements between key macroeconomic variables. This study will concentrate on the US (New York) and three European Stock markets (London, Paris and Frankfurt).

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