International portfolio diversification: A study of linkages among the U.S., European and Japanese equity markets

In this paper, we examine the short-term linkages among five leading stock markets with the objective of evaluating the case for international portfolio diversification as well as the stability of stock market interdependence after an exogenous shock. We utilize daily closing equity price data from U.S., U.K., France, Germany and Japan during the period from January 1999 to February 2002 and investigate the joint impact of any four equity markets on the fifth market. The findings indicate that even though the interdependencies among the markets are significant, there is still room for international portfolio diversification. Also, the study provides mixed results for the hypothesis that the international market correlations change after an exogenous shock. The tests of stability of correlations are based on before-and-after analyses of two events: the introduction by the European Union of the euro as official currency and the September 11, 2001, terrorist events in U.S.