روند تکاملی یکپارچه سازی بین المللی بازار سهام و اوراق قرضه: نفوذ اتحاد پولی اروپا

This paper examines the dynamic relationship between daily stock and government bond returns of selected countries over the past decade to infer the state and progress of inter-financial market integration. We proceed to empirically investigate the influence of the European Monetary Union (EMU) on time variations in inter-stock–bond market integration/segmentation dynamics using a two-step procedure: First, we document the downward trends in time-varying conditional correlations between stock and bond market returns in European countries, Japan and the US. Second, we investigate the causality and determinants of this interdependent relationship, in particular, whether the various macroeconomic convergence criteria associated with the EMU have played a significant role. We find that real economic integration and the reduction in currency risk have generally had the desired effect on financial integration but monetary policy integration may have created uncertain investor sentiments on the economic future of the EMU, thereby stimulating a flight to quality phenomenon.

Financial market integration is a central theme in international finance and the benefits of economic growth via risk sharing, improvements in allocational efficiency and reductions in macroeconomic volatility and transaction costs are all well accepted (see Prasad et al.’, 2003 and Baele et al.’, 2004). Whilst financial market integration encompasses many different aspects of the complex inter-relationships across various financial markets, we focus on the nature and extent of interdependence (co-movements) across daily asset returns.1 Whilst international integration within specific financial asset markets has received much attention, the subject of integration across different financial asset markets has not, despite its importance for investors’ asset allocation and portfolio risk management decisions. This study investigates stock and bond market integration over time within a common market jurisdiction as we are motivated by: recent developments on stock–bond return co-movements in financial economics; and the historical European Economic and Monetary union (EMU) experience. Co-movements in asset market returns provide indirect evidence on financial markets’ expectations and their reaction to common information that are priced into different asset types. To our best knowledge, co-movements in stock and bond returns have not been previously interpreted in an inter-financial market integration context and to this end, our main contribution is in merging these two strands of literature to shed new light on both. Moreover, with the implementation of a currency union and associated stabilization of macroeconomic fundamentals in Europe, we also ask whether there have been any influences on the integration process between stock and bond markets as this has not been addressed in the existing market integration literature. The nature of stock–bond market co-movements has perplexed researchers in financial economics for years and there have been many attempts to understand their fundamental relationship. Existing stock–bond studies are generally in agreement on how stock and bond returns co-move over time but not why they co-move. Early studies to address the latter can be represented by Campbell and Ammer (1993) as they implicitly assume time invariance in the stock–bond relation, and conclude that observed levels cannot be justified by economic fundamentals. In this thread, Engsted and Tanggaard (2001) is relevant for the European markets. Most recently, researchers modeled the time-varying risk premia in their investigation and established that stock and government bond returns exhibit a modest positive correlation over a long horizon but the relationship is a dynamic one, meaning that the amount of portfolio diversification with a given asset allocation is constantly changing (see inter alia Connolly et al.’, forthcoming and Fleming et al.’, 1998). In particular, Cappiello et al. (2003) and Scruggs and Glabadanidis (2003) investigate the asymmetric nature of stock and bond market conditional variances and their co-movement. In the asset pricing vein, Ilmanen (1995) and Barr and Priestley (2004) suggest that world stock and bond markets are largely segmented and that further understanding of their joint behaviour is needed. Informational linkages have formed the basis of most recent theoretical models on time-varying stock–bond return co-movements. There are two main channels through which information drives that relationship: (1) common sources of information influencing expectations in both stock and bond markets at the same time and (2) sources of information that only alter expectations in one market but spill over into the other market. Informational spillovers between the two markets are the crux of dynamic cross-market hedging studies (see Fleming et al.’, 1998 and Kodres and Pritsker’, 2002) and the motivation behind analyzing co-movements in stock and bond market liquidities and the interaction with returns, volatility and order flow in Chordia et al. (2005). It is argued that a shock in one asset market may generate cross-market asset rebalancing thereby generating volatility linkages. Generally, government bonds are deemed to be a safe haven for investors engaging in a “flight to quality” in times of financial turmoil. As investors substitute safe assets for their risky ones, bond and stock market returns become negatively correlated (see Chordia et al.’, 2005, Connolly et al.’, forthcoming and Hartmann et al.’, 2004). Most recently, stock market uncertainty has been provided by Connolly et al. (forthcoming) as a key explanation for the stock–bond return relation. They use implied volatilities from equity index options to reflect stock market uncertainty, emphasizing that this should be positively related to economic-state uncertainty in the sense of Veronesi (1999). In spite of existing work, the explanation for long-term co-movements in stock and bond returns remains conjectural. In this paper, we contribute to the literature by interpreting stock–bond return co-movements in a new light. They have traditionally been modeled as statistical contemporaneous correlations or covariances but have not been viewed as an integral aspect of inter-stock–bond market integration. Hence, we analyse the extent to which international stock–bond market integration has been influenced by the EMU by documenting and determining the conditional correlation dynamics between daily stock and bond returns in a bivariate EGARCH model from 2/3/1994 to 19/9/2003. Our main hypothesis is that economic policies directed at achieving convergence in exchange rates, monetary stance and the real economy (three channels which have characterized the degree of economic integration across countries with the EMU) have been relevant and critical common influences on the extent of systemic stock and bond market integration in Europe and the rest of the world. We utilize additional information captured in a seemingly unrelated regression (SUR) to evaluate the significance of these economic channels amongst seasonal effects. Our new findings are (i) as intra-stock and bond market integration with the EMU has strengthened in the sample period, inter-stock–bond market integration has trended downwards to zero and even negative mean levels in most European countries, Japan and the US, consistent with a flight to quality phenomena in international financial markets; (ii) cross-market volatilities have overall stabilizing effects but bond market return shocks have more influence; (iii) the EMU has caused the inter-stock–bond market segmentation dynamics (in a Granger sense) only in European countries; (iv) real economic integration with the EMU and reduction in currency risk with the introduction of the Euro have generally stimulated inter-financial market integration but increasing monetary policy convergence with the EMU may have created uncertain investor sentiments in the international financial system; and (v) there is no evidence of calendar effects in international inter-stock–bond market integration, particularly the January and day of the week effect. The remainder of this paper is organized as follows: Section 2 introduces the data used for documenting and explaining the dynamics of stock–bond market integration. Section 3 focuses discussion on model selection whilst Section 4 considers the progress of financial integration between stock and government bond markets over time. Section 5 investigates the causality and determinants of time-varying integration across stock and bond markets. Finally, concluding remarks are made in Section 6.

The aim of this paper is to investigate whether time-varying co-movements between daily government bond and stock returns over the past decade have been affected by the implementation of the EMU. We find that as intra-stock and bond market integration with the EMU has strengthened in the sample period, inter-stock–bond market integration at the country level has trended downwards to zero and even negative mean levels in most European countries, Japan and the US – consistent with a flight to quality phenomena in international financial markets. We find further evidence to support this in estimated sign and volume effects on cross-market volatility spillovers in a bivariate EGARCH model and we note that bond market return shocks have more influence than stock market shocks consistent with existing literature. There is convincing evidence that the introduction of the monetary union has Granger caused the apparent segmentation between bond and stock markets within Europe but not outside. Moreover, real economic integration with the EMU and reduction in currency risk with the Euro have generally stimulated inter-financial market integration but the adoption of a common monetary policy may have brought about investor concerns on the future of macroeconomic fundamentals in Europe and the international financial system, inducing a flight to government bonds, a perceived safe haven asset. To this end, the EMU has increased benefits of diversification across stocks and government bonds at the country level. There are no clear seasonal patterns in inter-market integration/segmentation dynamics between daily government bond and stock returns in this international study. We have made significant contributions to the broad finance literature on many levels, including (i) providing a new application of stock–bond co-movements to proxy inter-financial market integration over time; (ii) illustrating a two-step methodology that is suitable for this new application; (iii) using higher-frequency (daily) data to investigate international stock–bond co-movements; (iv) improving understanding on cross-market conditional volatility interdependencies and correlations at the country level; (v) establishing the direction of causality for inter-financial market integration and monetary union adoption; and (vi) providing an alternative theoretical explanation for stock–bond co-movements by using macroeconomic convergence criteria associated with optimal currency area studies and reinforced with a robust stock market uncertainty measure to study international inter-stock–bond market integration. This paper has important implications for both investors and policy makers. For investors, inter-stock–bond market segmentation at the country level means that diversifications benefits have increased for even domestic asset allocations. For policy makers, the process of monetary policy coordination is creating heightened economic uncertainty in financial markets and financial system instability may become more pronounced as asset markets of the same type become more interdependent and asset markets in the same jurisdiction continue to react to those developments.