An analysis of South-Eastern European stock markets: Evidence on cointegration and portfolio diversification benefits

• We investigated whether South-Eastern European (SEE) stock markets and their developed counterparts are integrated.
• We examined whether time-varying cointegration between markets rules out the possibility of portfolio diversification benefits.
• We show that the SEE markets and two developed counterparts (Germany, and the UK) are weakly cointegrated over the period of investigation.
• Our portfolio analysis results indicate the existence of diversification benefits despite evidence of increased correlation between returns as well as evidence of dynamic cointegration.

This paper investigates whether the South-Eastern European (SEE) stock markets of Bulgaria, Croatia, Romania, Slovenia and Turkey are integrated with their developed counterparts in Germany, the UK and the USA. Using static cointegration analysis, we find that the SEE markets are cointegrated with the German and the UK markets over the period 2000–2013, but not with the USA market. Furthermore, the dynamic cointegration analysis reveals the existence of time-varying cointegration among the SEE markets and their developed counterparts, particularly during sub-periods that reflect the effects of common shocks such as a financial crisis. Therefore, one general conclusion we report is that both static and dynamic cointegration tests are necessary to analyse the extent to which international stock markets are cointegrated. The second question we address is whether any diversification benefits existed during the period that encompasses the recent financial crisis. We report that diversification benefits did exist from September 2007 to June 2013 despite evidence of dynamic cointegration during most of the crisis period from September 2008 to May 2010. Therefore, we suggest that any evidence of dynamic cointegration must be supplemented with evidence from a portfolio analysis before conclusions are made about the absence or existence of diversification benefits.