Long and short term dynamic causal transmission amongst international stock markets

This paper investigates the dynamic causal linkages amongst nine major inte rnational stock price indexes. In order to gauge the causal transmission pa tterns we employ very recent methods of: (i) vector error-correction modeli ng and (ii) level VAR modeling with possibly integrated and cointegrated pr ocesses, advocated by: (i) Toda and Phillips (Econometrica, 61 (1993) 1367) and (ii) Toda and Yamamoto (J. Econometrics, 66 (1995) 225), respectively. The paper illustrates how such methods may be appropriately augmented in a compatible fashion to unearth previously unfounded linkage properties inhe rent amongst a system of stock price indexes. In particular, we demonstrate that previous research, by using ordinary difference VARs, ignored an impo rtant component of linkages displayed purely over the long run. This untapp ed evidence essentially provides robust and very useful information to inte rnational financial analysts and investors. At a substantive level, results of this study tend to support the contention offered by several studies in the literature of significant interdependencies between the established OE CD and the Asian markets, and also the leadership of the US and UK markets over the short and long run. The levels VAR, however, illustrate the Japane se market's influence as an additional long run leader. Findings seem to be plausible given that these three markets (US, UK and Japan) have consisten tly contributed over 75% of global stock market capitalization over the maj or part of the sample under consideration. At a methodological level, this analysis also provides a primer for the wealth of applied financial econome tric research focusing on dynamic causal inference which involve systems co ntaining possibly integrated and cointegrated processes. (C) 2001 Elsevier Science Ltd. All rights reserved.