Comovements of Financial Markets in the EU countries

Abstract

This article examines comovements between stock and government bondmarkets in the EU countries. Previous authors mostly indicatedsignificant highly volatile comovements between the markets. Inaddition, it was proven in several markets that in times of financialcrisis the comovements between financial markets are becoming strongerand negative correlations appear indicating flight-to-quality fromstocks to government bonds. Despite of that, there exists a tendency toanalyze only financial markets of Eurozone countries leaving the rest ofthe EU members behind. The aim of this research was to fill this gap byproviding insights of co-movements between stocks and government bondmarkets of al thel EU countries together with recommendations forportfolio diversification.The first stage of the research was implemented by using Pearson'scorrelation coefficient. Logarithmic returns on 52 market indices wereused for calculations of correlation coefficients in the period of1993-2012. The second stage of the research included the estimation ofcorrelations in the period of 2008-2013, commonly referred to asfinancial crisis. In addition, statistical significance of coefficientswas evaluated by testing Fisher's null hypothesis.The results of the research show that majority of correlationcoefficients between stock and government bond indices were rather smalland not significant during the full sample period with the exception infinancial markets of Greece, Hungary, Lithuania and Romania (weak-mediumstatistically significant correlations). The results indicate financialmarkets in the countries mentioned being more related than in the restof the EU countries, not being suitable for diversification betweenasset classes. No significant negative correlation between marketindices in 1993-2013 was recorded implying that in times of stock marketfall government bond markets would not be the safe haven for investors.Analysis of comovements between stock and government bond markets of theEU countries in the period from 2008 resulted in increase of correlationcoefficients in 19 of 25 EU countries analyzed indicating strengthenedcomovements in times of financial stress. Despite of that, most of thesecorrelations were positive. This is not beneficial for investors asdiversification effect might disappear when it's most needed. Asexceptions should be mentioned Scandinavian countries where significantnegative correlation coefficients obtained between stock and governmentbond indices indicate an existence of flight-to-quality. This could notbe confirmed for the rest of the EU countries' markets.The results of the research partly comply with the results of previousstudies in the topic, mostly confirming the tendencies for biggest EUfinancial markets. The research can be further implemented towardsdifferent directions: inclusion of the US as the major financial market,concentration on the countries with strongest comovements and provisionof detailed estimation of them; inclusion of corporate bond indices;choice of other method for estimation of comovements between financialmarkets of the EU countries. Finally, the analysis needs more focus onthe investigation of the reasons for differences in the relationshipbetween financial markets.