Long and Short-Run Linkages in CEE Stock Markets: Implications for Portfolio Diversification and Stock Market Integration

Abstract

This paper examines the short- and long-term relationships between seven Central Eastern European (CEE) stock markets and two developed stock markets, namely the German market and the US market. Application of the Gonzalo and Granger (1995) methodology indicates that the examined stock markets are partially integrated, while there is also evidence that the five stock markets of Central Europe (Czech Republic, Hungary, Poland, Slovenia and Slovakia) together with the German and the US stock markets have a significant common permanent component, which drives this system of stock exchanges in the long run. Contrary, the Estonian and Romania markets are segmented. A DCC model indicates that the short - term interdependencies between the CEE stock markets and the developed stock markets have strengthened during the Asian and Russian crises but since then (except for the Czech Republic, Hungary, Poland) they returned almost to their initial (relatively low) levels. Moreover, significantly increased volatility is observed during the Russian crisis period for all the markets under enquiry.

Keywords: Central Eastern European equity markets, CEE, Market Integration, Common trends, DCC, SWARCH-L

JEL Classification: G15, C12, C32, F36