How close a relationship does a capital market have with other markets? A reexamination based on the equal variance test

• We extend the work of Lee et al. (2012) by allowing cross-sectional dependence.
• A new equal variance test is constructed to determine the degree of cointegration.
• Our results are robust to the cross-sectional dependence.
• The cross-sectional dependence can invalidate the test of Lee et al. (2012).

The cointegration test cannot discriminate closer relationships from cointegrating relationships. In most applications, we must assess the degrees of cointegrating relationships, for example, to examine the comovement between international stock markets using the cointegration methodology. Lee et al. (2012) introduced a variance test of cointegration equilibrium errors to measure the similarity of these relationships. However, the key assumption of cross-sectional independence between a panel of two country-pair squared cointegrating equilibrium errors in their model is not desirable. The appearance of cross-sectional dependence of individual (stock) markets in a panel is a common existence. The current paper shows that the consideration of cross-sectional dependence and the method of estimating long-run variance are important. Our results, which extend the cross-sectional dependence of some Asian stock markets during the Asian financial crisis (1997–1998) documented by Lee et al. (2012), indicate that the similarity of background and business cooperation (or trading activities) are all crucial factors for determining the price patterns by the “equal variance test” proposed in this paper. The analysis of the 2007–2009 global financial crisis is included to confirm the robustness of the results.