The Integration of the Chinese Stock Markets Following the Shanghai–Hong Kong Stock Connect: Evidence from Cointegration, Linear, and Nonlinear Causality Analysis

Abstract

This study examines the impact of the Shanghai–Hong Kong Stock Connect on the degree of financial integration between the Hong Kong stock market and the Shanghai and Shenzhen stock markets in mainland China. By applying cointegration tests and linear and nonlinear Granger causality techniques on market capitalization and market index, we find that the stock markets from mainland China are increasingly influencing the Hong Kong stock market after the introduction of the Stock Connect scheme. Following the scheme’s introduction, the cointegration relationship between China and Hong Kong in terms of market capitalizations and market indices is also increasing. Moreover, Granger causality effects on market capitalizations and market indices from China remain strong, while the directional Granger cause of the two variables from Hong Kong to China has become weak or been rejected. Our study indicates that further opening of the Chinese stock markets enhances their leading roles, given that market capitalizations and market indices exhibit the highest degree of explanatory power regarding market correction toward long-run equilibrium. However with nonlinear causality test, our results indicate that Hong Kong stock market is still relevant to understand and predict China stock market after the introduction of the Stock Connect scheme.

Keywords: financial integration, cointegration, Engle–Granger causality, error correction, nonlinear causality, multivariate setting

JEL Classification: F36, C22