Integration Level and the Hierarchical Structure of European Stock Markets in the Years 2004–2017

Abstract

The aim of this research is to conduct a dynamic analysis of the level of integration between the European stock markets including their hierarchical structure. The analysis of the structure of links between markets allows identifying those groups of markets that have a particularly strong impact on each other and those with weaker connections. That is an important issue from the point of view of investors as strong links between markets can significantly limit the benefits of internationally diversifying investment portfolios. The study has been carried out with the use of closing prices for 35 main European stock market indices for the time period from September 2014 to August 2017. In the first step, Ward’s method was utilized to analyze the hierarchical structure of the entire set of markets. This allowed to identify groups of markets with the strongest levels of interconnectedness. Next, the level of financial integration was analyzed for the entire group of markets and for smaller subsets of the sample with the use of dynamic integration indicator—calculated as the share of variance explained by the first principal component in the overall variance of the original variables. The indicator was calculated over a moving window. This allowed not only to distinguish groups of markets with higher levels of financial integration but also to identify periods of rising and falling integration.