Time Frequency Effects on Market Indices: World Commovements

Abstract

The international comovement of stock market indices is reviewed. The most powerful argument for cross-border investing is the risk reduction due to low correlation of world's stock markets. Diversifying risk has become even more important as financial markets globalize, helped by advanced information technology which lowers the transaction costs. Systematic risk is lowered through international diversification in markets with low correlation with domestic markets. Investors must be willing to take advantage of these correlations to reduce volatility in their portfolios. As such, we show the usefulness of wavelet analysis for financial relations. The current work tries to analyze the relationship among eleven stock indices using wavelet theory, applying the MODWT, cross-Wavelets techniques, and regression analysis for different time scales. The findings suggest that there is strong to moderate cointegration among many stock markets, and as such there is evidence of intra-continental relationships. We were thus able to disentangle different short, medium and long-run relations. The importance of historical transmissions is low for the period under analysis.

Keywords: stock market indices, maximal overlap discrete wavelet transform (MODWT), cross-wavelets, international co-movement, diversification