Public Sector Economics



An international integration history of the Zagreb Stock Exchange

Luka Šikić*
Mislav Šagovac**
Article   |   Year:  2017   |   Pages:  227 - 257   |   Volume:  41   |   Issue:  2
Received:  December 21, 2016   |   Accepted:  March 14, 2017   |   Published online:  June 15, 2017
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We investigate stock market co-movements among the Croatian and several other markets (in the US, UK, Germany, Austria, Poland, Czech Republic and Hungary) in the period from 3 September 1997 to 19 August 2016 with dynamic correlation coefficient models. This allows us to analyse long-term trends of the international financial integration of the Zagreb Stock Exchange in the last two decades as well as the separate impacts of major events that influenced financial markets during that period. Our results imply a relatively low level of international financial integration of the Croatian stock market, but some convergence in co-movement with the analysed markets over time is present. The strongest market co-movement is related to the subprime mortgage crisis, and EU accession seems to have made Croatian international integration less segmented.

Keywords:  stock market co-movement, Croatian international financial integration, dynamic correlation coefficient models

JEL:  G10, G15, N24

1 Introduction

The emerging European stock markets have brief histories compared to more mature markets. Most emerging European countries actively follow economic policies that lead towards more internationally integrated financial markets, yet full integration of these countries’ financial markets is far from complete. Since their initial trading sessions in the first half of the 1990s, the emerging European stock markets have had varied performances in terms of international integration. Horvat and Petrovski (2013) find that Central European stock markets are highly integrated into the global financial system, whereas those of South-Eastern Europe exhibit a much lower degree of integration. Due to the special characteristics of the Croatian transition process relative to other emerging EU countries (i.e. war destruction in the initial transition phase, delayed EU accession), its financial integration needs to be investigated individually.

In this paper, we examine the co-movement of the Croatian stock market with various European and global financial markets. We are interested in the long-term perspective of financial integration but investigate the impact of several major financial events in last two decades on the integration process as well. There has been some research on stock market integration and closely related topics for emerging European countries (Cappiello et al., 2006a; Egert and Kocenda, 2007; Horvat and Petrovski, 2013; Ivanov, 2014), but a detailed examination of the Croatian stock market is lacking. Therefore, we collect daily data on the closing prices of stock market indices from the Zagreb Stock Exchange and several European (UK – FTSE100, broad EU – STOXX600, German – DAX, Austrian – ATX, Polish – WIG20, Czech – PX and Hungarian – BUX) and global (US – S&P500) markets for the period of 3 September 1997 to 19 August 2016. We identified several important events from the literature on the stock market integration of emerging European countries: the Russian crisis (see Jochum et al., 1999; Gelos and Sahay, 2000), the dot-com crisis and the 9/11 shocks, the subprime mortgage crisis (see Gijka and Horvath, 2012), and EU accession (see Cappiello et al., 2016b). Next to these events, we analyse the full sample period as well.

The first significant financial shocks for emerging European markets were the Asian and Russian crisis but since it is hard to separate effects of these two events due to their chronological closeness, we investigate the Russian crisis only. The dot-com crisis was the following event that had a pronounced impact on the global financial system but we include the 9/11 shock in our analysis as well since it represents an important non-financial event that affected financial markets globally in that period. The next important event was the subprime mortgage crisis. It started in United States and propagated to the rest of the world through the financial system, in which emerging European countries were particularly affected. This makes it especially interesting as an event that affected the Croatian financial market as well. Finally, as well as a wider set of economic, social and political effects, EU accession implies the intensification of financial integration between Croatian and European markets. Therefore, it is important to analyse how EU accession affected co-movements among Croatian and other markets.

The analysis of Croatian international stock market integration is of interest to investors looking for diversification opportunities in emerging European countries. Investors who seek financing on the local capital market will be better informed about assessing risk related to the channels of financial shock propagation. The emerging European countries experienced a larger drop in economic activity in the recent financial crisis than other regions (Berglof et al., 2009), so the implications of this study have relevance for domestic macroeconomic and monetary policy. Melitz and Zumer (1999) and Baele et al. (2004) claim that integrated European capital markets may decrease risk and allow for better diversification, while Kassim (2010) states that the extent of integration is highly relevant in the context of countries aiming for macroeconomic harmonization. Therefore, the financial stability of emerging European markets is important for the stability of the whole region and also has implications for the economic stability of the EU.

We contribute to the existing literature in several ways. Firstly, we use data on the longest time span available and are therefore able to investigate the full history of Croatian stock market co-movements. This allows us to go into detail about different events during that period and put them in a comparative perspective. This is especially interesting with respect to Croatia’s EU accession, which was later than that of other new member states and should be analysed as a separate event. Secondly, our methodological approach makes use of both the dynamic conditional correlation model (DCC) of Engle and Sheppard (2001) and the asymmetric dynamic conditional correlation model (ADCC) of Cappiello et al. (2006a). It is reasonable to assume that correlations between Croatian and other stock markets are time-varying, these models accordingly being able to account for changing dynamics of the correlation structure and suitable for analysing different financial crises and events. Furthermore, by using both, symmetric and asymmetric volatility models we are able to check the impact of positive and negative news (shocks) on volatility. Thirdly, we analyse the co-movements between Croatian and different European and global markets, which allows us to inspect whether different financial incidents and other analysed events drive the correlation structure of these markets. Since similarities in the correlation of returns between different markets imply their closer integration we are also able to make some general conclusions about the structure of financial integration and transmission of global and regional financial shocks.

Our results suggest that the overall level of Croatian international financial integration is relatively low, average correlation in the full period amounting to around 0.25, compared to developed markets. However, there are some tendencies of cross-market correlations to converge over time, which reduces Croatian international market segmentation. The analysis also shows that the subprime crisis had the strongest effect on international market integration, whereas Croatia’s EU accession caused correlation coefficients to converge and somewhat reduced international market segmentation.

The article is organized as follows: section 2 gives an overview of related literature, while section 3 describes the data set and describes the empirical model. Section 4 presents the results and discusses implications. Concluding remarks are given in section 5.

2 Related literature

One of the main interests of the literature about short and long term relationships between stock markets in emerging European countries has been in implications of results for portfolio diversification opportunities. The findings of the literature have been somewhat mixed but mostly point to regional stock market interdependence and imply that there are only limited diversification opportunities for investors in emerging European countries. The results show that there is a longrun relationship among emerging EU stock markets, but much less evidence has been found on the relationship between them and world markets. This is supported in MacDonald (2001) and Voronkova (2004), which do not find any significant benefits of portfolio diversification when