The determinants of equity market correlation---A gravity model analysis

Abstract

This research extends the methodology of gravity model from trade area to asset markets and investigates bilateral stock-market correlation among 23 countries by utilizing new panel data set from time period 1995 to 2003. With market capitalization representing market size and distance proxying some informational asymmetries, it is found that geographic factors are not less related to the correlations as most people think. Instead, they still heavily determine the pattern of international stock markets correlations. Moreover, certain variables, such as the number of overlapping working hours of the stock exchanges and the colonial links between countries, have significantly positive relations with cross-country stock markets correlations. The key role of informational asymmetries has been confirmed to give some explanation of the theory of international diversification and suggestions on the international portfolio investment.