1 INTRODUCTION
The economic integration of international stock markets has become especially relevant over the last
two decades. The substantial
... [Show More] development of technology and the increased flow of capital between
countries are the main factors for this globalization process. Thus, understanding the linkages between
different financial markets is of great importance for portfolio managers and financial institutions.
Volatility, as measured by the standard deviation or variance of returns, is often used as a crude
measure of the total risk of financial assets (Brooks, 2002). Hence, when referring to international
equity markets integration, researchers not only investigate the return causality linkages, but also
measure volatility spillover effects. Information about volatility spillover effects is very useful for the
application of value at risk and hedging strategies.
Recently, with the role of the emerging markets becoming more important, economists not only
focus on developed countries, for example, United States, the United Kingdom, and Japan, but also
pay great attention to the emerging markets. For example, in the equity markets, the extent of the
linkages of the emerging stock market exchanges with developed stock market exchanges has
important implications for both the developing and the developed countries’ investors. If the emerging
market stock exchange is only weakly integrated with the developed market, it has the implication that
there would be portfolio diversification possibilities for developed countries’ investors through
including the emerging market stocks in their portfolio as this diversification should reduce risk, and
vice versa. On the contrary, if the emerging stock markets were fully integrated with the developed
stock markets, there would not be any portfolio diversification benefit for either developed and/or
emerging countries’ investors.
Several researches such as Kumar and Mukhopadhyay (2002) and Wong, Agarwal, and Du (2005)
support the notion that there is a correlation between the various markets globally. Furthermore, Yang
(2005) inspected the international stock exchange correlations between Japan and the Asian Four
Tigers (Hong Kong, Singapore, South Korea, and Taiwan) and found that stock exchange correlations
vary widely over time and volatilities seem to be contagious across the markets. The importance of
these studies was also confirmed by Levy and Sarnat (1970), in which they have shown how the
correlations between developed and developing countries provide a paramount risk-reduction benefit.
More recently, the focus of the studies of these topics shifted to the contagion effect of financial
crisis. For example, Lucia and Bernadette’s (2010) analysis show the evidence that the global financial
crisis in 2007–2009 has been affecting differently the world economic regions. In the same year,
Charles, Pop, and Darne (2011) discovered that during the crisis, both Islamic and conventional indices
were affected to the same degree by variance changes. However, in terms of portfolio diversification,
3
Achsani, Effendi, and Abidin (2007), in general, find that the interdependence of the Islamic stock
markets tends to be asymmetric across a wide geographical area. While there are strong correlations
between the Islamic stock indices of Indonesia and Malaysia, the US and Canada, and Japan and Asia
Pacific, this is not exactly the case across the region. [Show Less]