Determinants of Stock Market Correlations. Accounting for Model Uncertainty and Reverse Causality in a Large Panel Setting

REM Working Paper 246-2022

38 Pages Posted:

See all articles by António Afonso

António Afonso

University of Lisbon - ISEG (School of Economics and Management); UECE (Research Unit on Complexity and Economics); ISEG Lisbon School of Economics and Management,Universidade de Lisboa; REM - Research in Economics and Mathematics

Krzysztof Beck

Lazarski University

Karen Jackson

University of Westminster

Date Written: September 13, 2022

Abstract

We examine 22 determinants of stock market correlations in a panel setting with 651 country pairs of developed economies over the 2001-2018 period, while accounting for model uncertainty and reverse causality. On the one hand, we find, that a number of determinants, well established in the literature, e.g. trade, institutional distance, and exchange rate volatility fail the robustness test. On the other hand, we find strong evidence supporting several others: (1) inertia, with current correlation being the best single predictor of the future stock market correlation (2) positive impact of the market size (3) imperative role of the interconnected financial factors: capital mobility, financial development, and portfolio equity flows. With the expected future growth of economies and their capital markets as well as deepening financial liberalization, this paper brings strong support to the hypothesis of diminishing international diversification potential.

Keywords: stock market correlations, stock market comovement, financial development, Bayesian model averaging, OECD countries

JEL Classification: G10, G11, G15, F62

Suggested Citation

Afonso, António and Beck, Krzysztof and Jackson, Karen, Determinants of Stock Market Correlations. Accounting for Model Uncertainty and Reverse Causality in a Large Panel Setting (September 13, 2022). REM Working Paper 246-2022, Available at SSRN: https://ssrn.com/abstract=

António Afonso (Contact Author)

University of Lisbon - ISEG (School of Economics and Management) ( email )

R. Miguel Lupi, 20
Lisbon, 1248-078
Portugal
+351 21 392 5985 (Phone)
+351 21 396 6407 (Fax)

HOME PAGE: http://www.iseg.ulisboa.pt/aquila/homepage/aafonso/research

UECE (Research Unit on Complexity and Economics)

Rua Miguel Lupi 20
Lisbon, 1249-078
Portugal
+351-213 925 912 (Phone)
+351-213 971 196 (Fax)

HOME PAGE: http://uece.rc.iseg.ulisboa.pt/

ISEG Lisbon School of Economics and Management,Universidade de Lisboa ( email )

Rua do Quelhas 6
LISBOA, 1200-781
Portugal

REM - Research in Economics and Mathematics ( email )

ISEG, Universidade de Lisboa
Rua Miguel Lupi, 20
Lisboa, 1249-078
Portugal

HOME PAGE: http://rem.rc.iseg.ulisboa.pt/

Krzysztof Beck

Lazarski University ( email )

Świeradowska 43 Warszawa
Warsaw, 02-662
Poland

Karen Jackson

University of Westminster ( email )

35 Marylebone Road
London NW1 5LS
United Kingdom

HOME PAGE: http://karen-jackson.com

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