Capital Market Integration in the Middle East and North Africa and its Implications for International Portfolio Allocation

Abstract

The objective of this paper is to study capital market integration in the MENA countries and its implications for an international portfolio investment allocation. Using four co-integration methodologies, we significantly reject the hypothesis of a stable, long run bivariate relationship and between each of these markets and the European Monetary Union, the USA, and a regional benchmark. This indicates the existence of significant diversification opportunities for the three categories of investors. A time-varying analysis based on Barari (2004) suggests that the MENA markets have recently started moving towards international financial integration. They also seem to display heterogeneous reactions to financial, economic and political events, and should therefore not be treated as a block for global allocation purposes. Finally, adjusting these scores by market capitalization highlights that Israel and Turkey are the most promising markets in the region. They are followed by Egypt, Jordan and Morocco, while Tunisia and Lebanon seem to be lagging behind.

Keywords: Stock Market Integration, Portfolio Diversification, MENA markets, Time-varying methods

JEL Classification: G11, G12, G15