A COINTEGRATION STUDY AMONG SELECTED FINANCIAL MARKETS OF MAJOR G7 COUNTRIES (USA, JAPAN &CANADA), EXCHANGE RATES OF INDIA & LIBOR

A COINTEGRATION STUDY AMONG

SELECTED FINANCIAL MARKETS OF MAJOR

G7 COUNTRIES (USA, JAPAN &CANADA),

EXCHANGE RATES OF INDIA & LIBOR

A Dissertation submitted for the degree of Master of Business Administration

2017

Submitted By

Debabrata Nayak

Roll No: PC 15MBA023

Under the Guidance of

Sri Sisir Ranjan Dash

Department of Professional Courses

Gangadhar Meher University

Sambalpur – 768004

Odisha

DECLARATION

1

I do hereby declare that the work incorporated in this dissertation is original and the dissertation

entitled “A COINTEGRATION STUDY AMONG SELECTED FINANCIAL MARKETS OF MAJOR G7 COUNTRIES (USA, JAPAN &CANADA), EXCHANGE RATES OF INDIA &LIBOR “submitted by me for

the MBA degree is the record of work carried out by me during the period from January to April 2017

under the guidance of Sri Sisir Ranjan Dash, Department of Professional Courses, Gangadhar Meher

University, Sambalpur – 768004 and has not been formed the basis for the award of any degree in this

or any other University .

I further declare that the material obtained from other sources has been duly acknowledged in

the dissertation.

(Debabrata Nayak)

Signature of the Candidate

Sri Sisir Ranjan DashMA (Economics), MBA, Ph. D. (Cont.), NETSr. Lecturer

2

Department Professional Courses

Gangadhar Meher University, Sambalpur – 768004, Odisha

Phone- 0663 2522543, 9439213351(M),

email : [email protected]

CERTIFICATE

This is to certify that the dissertation titled “A COINTEGRATION STUDY AMONG SELECTED FINANCIAL MARKETS OF MAJOR G7 COUNTRIES (USA, JAPAN &CANADA), EXCHANGE RATES OF INDIA & LIBOR”, submitted by Debabrata Nayak bearing Roll No: PC15MBA023 to Department of

Professional Courses, Gangadhar Meher University, Sambalpur – 768004, Odisha for a Master in

Finance and Control degree, is the product of an authentic research work undertaken by the candidate

under my supervision and guidance.

As far as I know, the materials in this work have not been submitted previously to any

University for obtaining any degree / diploma. I am satisfied that this dissertation adequately meets the

academic standards for a MBA Degree.

Sri Sisir Ranjan Dash

Supervisor

CONTENTS

Chapter Topic Page No.

3

mailto:[email protected]

1

1.1

1.2

1.3

1.4

1.5

1.6

Introduction

Motivation of the Study

What is the 'group of seven - g-7

Breaking down 'group of seven - g-7

Role of g-7

Expansion to g-8

Diminishing power and role

2

2.1

2.2

2.3

2.4

2.5

2.6

Profiling of Sample Countries (India, USA,Canada&Japan)

Chapter Objectives

India

USA

Canada

Japan

Conclusion

3

3.1

3.2

3.3

Review of Literature: A Theoretical Analysis

Chapter Objectives

Review of Literature

Research Questions

4

4.1

4.2

4.3

4.4

Research Designs

Chapter Objectives

Research Objectives

Type of Data Used

Type of Statistical Tools Used

CONTENTS

Chapter Topic Page No.

4

5

5.1

5.2

5.3

5.4

5.5

5.6

5.7

5.8

5.9

5.10

5.11

5.12

5.13

5.14

5.15

5.16

5.17

Analysis and Findings

Data Analysis

Unit root testing

Key findings – descriptive statistics (india and all stock indices)

Key findings – adf & pp test in level data

Key findings – adf & pp test - first difference data

Key findings – test of cointegration


Key findings – descriptive statistics (india and all exchange rates)


Key findings – adf & pp test in first difference data



Key findings – descriptive statistics (india and all exchange rates)


Key findings – adf & pp test in first difference data



6

6.1

Conclusion and Policy Implication

Conclusion

References

ABSTRACT

5

The group of seven industrialized countries most popularly known as G7 nations

comprises of USA, UK, Canada, France, Italy, Germany and Japan. They are not only famous

for the level of their economic development but also they are known for having the most

developed financial markets in the world. The very objective of financial liberalization in

India being the integration with the developed financial markets, the present study is an

attempt to detect integration by implementation of cointegration test prescribed by Engle and

Granger (1987). We have taken the major stock indices of the G7

countries(USA,CANADA&JAPAN) and implemented Augmented Dickey-Fuller test

(ss1979) of them with exchange rates of Indian currency with their respective currencies.

Additionally, we have also performed cointegration tests of stock prices with LIBOR . The

results of the study shows lack of cointgration among the selected time series which means

India is yet to have a fair degree of integration with the financial markets of the group of

seven industrialized countries (USA,CANADA&JAPAN).

Keywords: Cointegration, Unit Root, ADF Test, Engle & Granger Test.

6

CHAPTER 1

INTRODUCTION

CHAPTER 1: INTRODUCTION

7

1.1 MOTIVATION OF THE STUDY

Uncovered interest rate parity (henceforth UIP) suggests that any arbitrage opportunity

between interest-earning assets, of different economies but with similar characteristics, will

disappear due to exchange rate movements. A positive shock to the domestic interest rate vis-

à-vis the foreign interest rate will lead to the depreciation of the home currency and vice

versa. UIP plays a critical role in most exchange rate determination theories, such as the

monetary exchange rate model, Dornbusch’s (1976) overshooting model and Krugman’s

(1991) target zone model. Also central banks frequently count on this relationship for

anchoring exchange rate expectations in the economy (Kalyvitis and Skotida, 2010).

Given the crucial role played by UIP in exchange rate theories and exchange rate stabilization

policies, this relationship warrants more detailed investigation. Unambiguous evidence

supporting UIP will not only increase the confidence in the existing exchange rate models but

may also enhance the quality of monetary policy decision-making. This research is an effort

in this direction.

This paper extends the existing UIP literature by zooming in on important issues affecting

this relationship. First, I use a multi-currency setup to exploit cross currency correlation.

Some previous studies using Seemingly Unrelated Regression Equations (SURE), such as

Flood and Rose (1996) and Mark and Wu (1998), have exploited cross currency correlations.

However, most studies investigate UIP mostly bilaterally. In my view, bilateral studies

implicitly impose restrictions on the third-country effect, which may play an important role in

determining exchange rates. This is equally true for studies using a panel setup that ignores

cross sectional dependence. In a globalized world, any shock to the US debt market say, will

not only affect the Japanese debt market but also the Euro debt market. Therefore, an interest

rate shock in the US will not only affect the US Dollar and the Japanese Yen exchange rate or

the US Dollar and the Euro exchange rate, but also the Euro-Yen exchange rate. Studies on

UIP have mostly ignored this cross currency correlation.

Second, instead of using domestic interest rates I use London Interbank Offered Rates

(LIBOR). LIBOR is an indicative interbank rate for specific currencies based on the

nonbinding quotes in the London interbank market.LIBOR rates are widely used as

benchmarks in global financial transactions. The statistical evaluation supports LIBOR as a

substitute for domestic interest rates. Factor analysis shows that the LIBOR rates are defined

8

by only one factor, the domestic interest rates. Using LIBOR has several advantages. For

instance, the currency specific LIBOR rates have similar transaction costs for the assets

denominated in various currencies, while capital is perfectly mobile. Juselius and MacDonald

(2004), Harvey (2005) and Ichiue and Koyama (2007) have used LIBOR as a proxy for

Japanese domestic rates, arguing that the thin and heavily regulated Japanese money market

in the eighties and nineties was less reflective of Japan’s economic fundamentals.

Finally, following a suggestion of Moon and Perron (2005), we take as our null hypothesis

that UIP holds (the slope coefficient is unity). Often the null hypothesis tested is that the

slope coefficient is not different from zero, which on rejection provides support for the

alternative hypothesis that the slope coefficient is different from zero. According to Moon

and Perron (2005), such a test design has a strong bias towards the null hypothesis, which is

rejected only when there is a strong support against it. Moreover, when the null of a zero

slope coefficient cannot be rejected, it is difficult to conclude whether the theory is rejected

or the power of the test is low.

My estimates using monthly data for the period July 1997 to December 2016 support UIP

over the short-term horizon for currencies from advanced countries. Moreover, our currency

specific estimates show that the null hypothesis of a unit coefficient can generally not be

rejected at the 5% level of significance. However, for the Japanese Yen and the Swiss Franc,

the slope coefficients are negative. This finding is consistent with the argument put forward

by Bansal and Dahlquist (2000) and Ballie and Kalic (2006) that deviations from UIP appear

only when the US interest rate exceeds the foreign interest rate (‘state dependence’). Once we

incorporate the negative interest rate differential, UIP cannot be rejected for the Japanese Yen

and the Swiss Franc. Our results show that cross currency effects play an important role in

determining the exchange rate between currencies. Finally, we also find some support for

Dornbusch’s (1976) overshooting hypothesis for exchange rates, specifically for the Japanese

Yen and the Swiss Franc against the US Dollar, suggesting that ‘state dependence’ could also

be instrumental in explaining exchange rate overshooting.

1.2 WHAT IS THE 'GROUP OF SEVEN - G-7

The Group of Seven (G-7) is a forum of the world's seven most industrialized economies.

The G-6 was formed in 1975 and consisted of France, Germany, Italy, Japan, the United

9

States and the United Kingdom; Canada was invited to join the group in 1976. G-7 officials

meet to discuss international economic and monetary issues.

1.3 BREAKING DOWN 'GROUP OF SEVEN - G-7

The G-7 meets on an annual basis in a rotating member country. The president of the G-7

rotates on an annual basis among the member nations. France hosted the first meeting in

1975, featuring the original G-6 nations. The first meeting with all G-7 nations was held in

Puerto Rico in 1976, hosted by the United States.

1.4 ROLE OF G-7

The G-7's major role is to discuss and work through world issues. The seven nations

represent around 50% of the global economy. Through the years, the G-7 has been vocal

about preventing the overall global economy from entering a recession. The group has

discussed financial crises, monetary systems and major world crises, such as oil shortages.

Finance ministers from the membership countries often meet annually or more frequently to

work to improve the economies of member countries and the world.

1.5 EXPANSION TO G-8

In 1998, Russia was added to the G-7 as a full member, making the group of world leaders

the G-8. Russia was added shortly after the Cold War in a symbolic but highly contested

move. Former U.S. President Bill Clinton was one G-7 members who pushed for Russia to be

welcomed in to the group. Russia made the G-7 into the G-8 from 1998 to 2014. In 2014,

Russia was suspended from the group after the annexation of Crimea and tensions in Ukraine.

The original formation of the G-6 was made up of the major non-communist powers. The

inclusion of Russia was seen as a move to help the post-Soviet Union Russia have a say in

world issues.

1.6 DIMINISHING POWER AND ROLE

The G-7 has been criticized for not including emerging markets or representing enough of the

overall global economy. From time to time, the G-7 welcomes in guest nations that act as

non-members. The European Union has participated fully in the G-7 since 1981 as a non-

enumerated member. The G-20, created in 1999, includes all the members of the G-7 plus 12

additional countries. The 20th representative is the European Union. The G-20 includes

10

emerging markets, such as China, Brazil, India, Mexico and South Africa. With the

membership of emerging markets, the G-20 has a better firsthand look at global economic

growth.

11

CHAPTER -2

PROFILING OF SAMPLE

COUNTRIES

12

CHAPTER 2: PROFILING OF THE SAMPLE COUNTRIES

2.1 CHAPTER OBJECTIVES

Following the above discussion, as there are four countries i.e. India, USA, Canada, and

Japan who are members of G-7 countries (expect India) have been selected for the present

study, this chapter has been written with the following objectives:

1. To profile the sample countries i.e. India, USA, Canada, Japan on the basis of their

geography.


demography.


economy.

2.2 INDIA

India, officially the Republic of India is a country in South Asia. It is the seventh-largest

country by area, the second-most populous country (with over 1.2 billion people), and the

most populous democracy in the world. It is bounded by the Indian Ocean on the south, the

Arabian Sea on the southwest, and the Bay of Bengal on the southeast. It shares land borders

with Pakistan to the west China, Nepal, and Bhutan to the northeast; and Myanmar (Burma)

and Bangladesh to the east. In the Indian Ocean, India is in the vicinity of Sri Lanka and the

Maldives. India's Andaman and Nicobar Islands share a maritime border with Thailand and

Indonesia.

In 2015, the Indian economy was the world's seventh largest by nominal GDP and third

largest by purchasing power parity. Following market-based economic reforms in 1991, India

became one of the fastest-growing major economies and is considered a newly industrialised

country. However, it continues to face the challenges of poverty, corruption, malnutrition,

and inadequate public healthcare. A nuclear weapons state and regional power, it has the third

largest standing army in the world and ranks sixth in military expenditure among nations.

India is a federal constitutional republic governed under a parliamentary system and consists

of 29 states and 7 union territories. It is a pluralistic, multilingual and multi-ethnic society

and is also home to a diversity of wildlife in a variety of protected habitats.

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2.2.1 GEOGRAPHY OF INDIA

India comprises the bulk of the Indian subcontinent, lying atop the Indian tectonic plate, and

part of the Indo-Australian Plate. India's defining geological processes began 75 million years

ago when the Indian plate, then part of the southern supercontinent Gondwana, began a north-

eastward drift caused by seafloor spreading to its south-west, and later, south and south-east.

Simultaneously, the vast Tethyn oceanic crust, to its northeast, began to subduct under the

Eurasian plate. These dual processes, driven by convection in the Earth's mantle, both created

the Indian Ocean and caused the Indian continental crust eventually to under-thrust Eurasia

and to uplift the Himalayas. Immediately south of the emerging Himalayas, plate movement

created a vast trough that rapidly filled with river-borne sedimentand now constitutes the

Indo-Gangetic Plain. Cut off from the plain by the ancient Aravalli Range lies the Thar

Desert.

The original Indian plate survives as peninsular India, the oldest and geologically most stable

part of India. It extends as far north as the Satpura and Vindhya ranges in central India. These

parallel chains run from the Arabian Sea coast in Gujarat in the west to the coal-rich Chota

Nagpur Plateau in Jharkhand in the east. To the south, the remaining peninsular landmass, the

Deccan Plateau, is flanked on the west and east by coastal ranges known as the Western and

Eastern Ghats; the plateau contains the country's oldest rock formations, some over one

billion years old. Constituted in such fashion, India lies to the north of the equator between 6°

44' and 35° 30' north latitude[g] and 68° 7' and 97° 25' east longitude.

A shining white snow-clad range, framed against a turquoise sky. In the middle ground, a

ridge descends from the right to form a saddle in the centre of the photograph, partly in

shadow. In the near foreground, a loop of a road is seen.

The Kedar Range of the Greater Himalayas rises behind Kedarnath Temple (Indian state of

Uttarakhand), which is one of the twelve jyotirlinga shrines.

India's coastline measures 7,517 kilometres (4,700 mi) in length; of this distance, 5,423

kilometres (3,400 mi) belong to peninsular India and 2,094 kilometres (1,300 mi) to the

Andaman, Nicobar, and Lakshadweep island chains. According to the Indian naval hydro

graphic charts, the mainland coastline consists of the following: 43% sandy beaches; 11%

rocky shores, including cliffs; and 46% mudflats or marshy shores.

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Major Himalayan-origin rivers that substantially flow through India include the Ganges and

the Brahmaputra, both of which drain into the Bay of Bengal. Important tributaries of the

Ganges include the Yamuna and the Kosi; the latter's extremely low gradient often leads to

severe floods and course changes. Major peninsular rivers, whose steeper gradients prevent

their waters from flooding, include the Godavari, the Mahanadi, the Kaveri, and the Krishna,

which also drain into the Bay of Bengal;and the Narmada and the Tapti, which drain into the

Arabian Sea.Coastal features include the marshy Rann of Kutch of western India and the

alluvial Sundarbans delta of eastern India; the latter is shared with Bangladesh. India has two

archipelagos: the Lakshadweep, coral atolls off India's south-western coast; and the Andaman

and Nicobar Islands, a volcanic chain in the Andaman Sea.

The Indian climate is strongly influenced by the Himalayas and the Thar Desert, both of

which drive the economically and culturally pivotal summer and winter monsoons. The

Himalayas prevent cold Central Asian katabatic winds from blowing in, keeping the bulk of

the Indian subcontinent warmer than most locations at similar latitudes. The Thar Desert

plays a crucial role in attracting the moisture-laden south-west summer monsoon winds that,

between June and October, provide the majority of India's rainfall. Four major climatic

groupings predominate in India: tropical wet, tropical dry, subtropical humid, and montane.

2.2.2 DEMOGRAPHICS OF INDIA

India is the second most populated country in the world with nearly a fifth of the world's

population. According to the United Nations in July 2016, the population stood at

1,326,801,576.

India is projected to be the world's most populous country by 2022, surpassing China, its

population reaching 1.7 billion by 2050. Thus, India is expected to become the first political

entity in history to be home to more than 1.5 billion people. Its population growth rate is

1.2%, ranking 94th in the world in 2013. The Indian population reached the billion mark in

1998.

India has more than 50% of its population below the age of 25 and more than 65% below the

age of 35. It is expected that, in 2020, the average age of an Indian will be 29 years,

compared to 37 for China and 48 for Japan; and, by 2030, India's dependency ratio should be

just over 0.4.

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India has more than two thousand ethnic groups, and every major religion is represented, as

are four major families of languages (Indo-European, Dravidian, Austroasiatic and Sino-

Tibetan languages) as well as two language isolates (the Nihali language spoken in parts of

Maharashtra and the Burushaski language spoken in parts of Jammu and Kashmir).

Further complexity is lent by the great variation that occurs across this population on social

parameters such as income and education. Only the continent of Africa exceeds the linguistic,

genetic and cultural diversity of the nation of India.

Table2.1 Comparative demographics of India

Category Global Ranking

Area7th

Population2nd

Population growth rate102nd of 212

Population density24th of 212

Male to Female ratio, at birth 12th of 214

2.2.3 ECONOMY OF INDIA

The Economy of India is the 6th largest in the world with a GDP (a year's goods and

services) of $2.30 trillion (U.S.). If we consider PPP (purchasing power parity: how much

that money can buy in India compared to other countries), the economy is third largest (worth

$8.52 trillion U.S.). However due to India's huge population, the economy was still only

$6,209 (considering PPP) per person per year in 2015.

India's economy includes agriculture, handicrafts, industries, and a lot of services. Services

are the main source of economic growth in India today, though two-thirds of Indian people

earn their living directly or indirectly through agriculture. In recent times, due to its large

number of well-educated people who can speak English, India became a pioneer in

information technology.

16

For most of India's independent history, it had strict government controls in many areas such

as telecommunications (communication over long distances), banking and foreign direct

investment. Since the early 1990s, India has slowly opened up its markets by reducing

government control on foreign trade and investment. This was started by Manmohan Singh

under the leadership of P.V.Narasimha Rao.From then, the Indian Economy grew at a rapid

pace.

The social and economic problems India faces are the increasing population, poverty, lack of

infrastructure (buildings, roads, etc.) and growing unemployment. Although poverty has gone

down 10% since the 1980s, a quarter of India's citizens still cannot pay for enough food.

2.3 USA

The United States of America, commonly referred to as the United States (U.S.) or America,

is a constitutional federal republic composed of 50 states, a federal district, five major self-

governing territories, and various possessions. Forty-eight of the fifty states and the federal

district are contiguous and located in North America between Canada and Mexico. The state

of Alaska is in the northwest corner of North America, bordered by Canada to the east and

across the Bering Strait from Russia to the west. The state of Hawaii is an archipelago in the

mid-Pacific Ocean. The U.S. territories are scattered about the Pacific Ocean and the

Caribbean Sea. Nine time zones are covered. The geography, climate and wildlife of the

country are extremely diverse.

At 3.8 million square miles (9.8 million km2) and with over 324 million people, the United

States is the world's third- or fourth-largest country by total area,third-largest by land area,

and the third-most populous. It is one of the world's most ethnically diverse and multicultural

nations, and is home to the world's largest immigrant population. The capital is Washington,

D.C. and the largest city is New York City; the other major metropolitan areas, all with

around five million or more inhabitants, are Los Angeles, Chicago, San Francisco, Boston,

Dallas, Philadelphia, Houston, Miami, and Atlanta.

Paleo-Indians migrated from Asia to the North American mainland at least 15,000 years ago.

European colonization began in the 16th century. The United States emerged from 13 British

colonies along the East Coast. Numerous disputes between Great Britain and the colonies

following the Seven Years' War led to the American Revolution, which began in 1775. On

July 4, 1776, during the course of the American Revolutionary War, the colonies

17

unanimously adopted the Declaration of Independence. The war ended in 1783 with

recognition of the independence of the United States by Great Britain, representing the first

successful war of independence against a European power. The current constitution was

adopted in 1788, after the Articles of Confederation, adopted in 1781, were felt to have

provided inadequate federal powers. The first ten amendments, collectively named the Bill of

Rights, were ratified in 1791 and designed to guarantee many fundamental civil liberties.

The United States embarked on a vigorous expansion across North America throughout the

19th century, displacing American Indian tribes, acquiring new territories, and gradually

admitting new states until it spanned the continent by 1848. During the second half of the

19th century, the American Civil War led to the end of legal slavery in the country. By the

end of that century, the United States extended into the Pacific Ocean, and its economy,

driven in large part by the Industrial Revolution, began to soar. The Spanish–American War

and World War I confirmed the country's status as a global military power. The United States

emerged from World War II as a global superpower, the first country to develop nuclear

weapons, the only country to use them in warfare, and a permanent member of the United

Nations Security Council. The end of the Cold War and the dissolution of the Soviet Union in

1991 left the United States as the world's sole superpower. The U.S. is a founding member of

the United Nations, World Bank, International Monetary Fund, Organization of American

States (OAS), and other international organizations.

The United States is a highly developed country, with the world's largest economy by

nominal GDP and second-largest economy by PPP. It ranks highly in several measures of

socioeconomic performance, including average wage, human development, per capita GDP,

and productivity per person. While the U.S. economy is considered post-industrial,

characterized by the dominance of services and knowledge economy, the manufacturing

sector remains the second-largest in the world. Though its population is only 4.3% of the

world total, the United States accounts for nearly a quarter of world GDP and over a third of

global military spending, making it the world's foremost economic and military power. The

United States is a prominent political and cultural force internationally, and a leader in

scientific research and technological innovations.

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2.3.1 GEOGRAPHY OF USA

The term "United States", when used in the geographical sense, is the contiguous United

States, the state of Alaska, the island state of Hawaii, the five insular territories of Puerto

Rico, Northern Mariana Islands, U.S. Virgin Islands, Guam, and American Samoa, and minor

outlying possessions. The United States shares land borders with Canada and Mexico and

maritime borders with Russia, Cuba, and the Bahamas in addition to Canada and Mexico.

From 1989 through 1996, the total area of the US was listed as 9,372,610 km2 (3,618,780 sq

mi) (land + inland water only). The listed total area changed to 9,629,091 km2 (3,717,813 sq

mi) in 1997 (Great Lakes area and coastal waters added), to 9,631,418 km2 (3,718,711 sq mi)

in 2004, to 9,631,420 km2 (3,718,710 sq mi) in 2006, and to 9,826,630 km2 (3,794,080 sq

mi) in 2007 (territorial waters added). Currently, the CIA World Factbook gives 9,826,675

km2 (3,794,100 sq mi), the United Nations Statistics Division gives 9,629,091 km2

(3,717,813 sq mi), and the Encyclopædia Britannica gives 9,522,055 km2 (3,676,486 sq mi)

(Great Lakes area included but not coastal waters). These sources consider only the 50 states

and the Federal District, and exclude overseas territories.

By total area (water as well as land), the United States is either slightly larger or smaller than

the People's Republic of China, making it the world's third or fourth largest country. China

and the United States are smaller than Russia and Canada in total area, but are larger than

Brazil. By land area only (exclusive of waters), the United States is the world's third largest

country, after Russia and China, with Canada in fourth. Whether the US or China is the third

largest country by total area depends on two factors: (1) The validity of China's claim on

Aksai Chin and Trans-Karakoram Tract. Both these territories are also claimed by India, so

are not counted; and (2) How US calculates its own surface area. Since the initial publishing

of the World Factbook, the CIA has updated the total area of United States a number of

times.

2.3.2 DEMOGRAPHICS OF USA

As of January 23, 2017, the United States has a total resident population of 324,420,000,

making it the third most populous country in the world. It is very urbanized, with 81%

residing in cities and suburbs as of 2014 (the worldwide urban rate is 54%). California and

Texas are the most populous states, as the mean centre of U.S. population has consistently

shifted westward and southward. New York City is the most populous city in the United

19

States. The total fertility rate in the United States estimated for 2015 is 1.84 children per

woman, which is below the replacement fertility rate of approximately 2.1. Compared to

other Western countries, in 2012, U.S. fertility rate was lower than that of France (2.01),

Australia (1.93) and the United Kingdom (1.92).However, U.S. population growth is among

the highest in industrialized countries, because the differences in fertility rates are less than

the differences in immigration levels, which are higher in the U.S. The United States Census

Bureau shows a population increase of 0.75% for the twelve-month period ending in July

2012. Though high by industrialized country standards, this is below the world average

annual rate of 1.1%.

There were about 125.9 million adult women in the United States in 2014. The number of

men was 119.4 million. At age 85 and older, there were almost twice as many women as men

(4 million vs. 2.1 million). People under 21 years of age made up over a quarter of the U.S.

population (27.1%), and people age 65 and over made up one-seventh (14.5%). The national

median age was 37.8 years in 2015.

The United States Census Bureau defines White people as those "having origins in any of the

original peoples of Europe, the Middle East, or North Africa. It includes people who reported

"White" or wrote in entries such as Irish, German, Italian, Lebanese, Near Easterner, Arab, or

Polish." Whites constitute the majority of the U.S. population, with a total of about

245,532,000 or 77.7% of the population as of 2013. Non-Hispanic whites make up 62.6% of

the country's population. Despite major changes due to immigration since the 1960s, and the

higher birth-rates of nonwhites, the overall current majority of American citizens are still

white, and English-speaking, though regional differences exist.

The American population almost quadrupled during the 20th century—at a growth rate of

about 1.3% a year—from about 76 million in 1900 to 281 million in 2000. It reached the 200

million mark in 1968, and the 300 million mark on October 17, 2006. Population growth is

fastest among minorities as a whole, and according to the Census Bureau's estimation for

2012, 50.4% of American children under the age of 1 belonged to minority groups.

Hispanic and Latino Americans accounted for 48% of the national population growth of 2.9

million between July 1, 2005, and July 1, 2006. Immigrants and their U.S.-born descendants

are expected to provide most of the U.S. population gains in the decades ahead.

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The Census Bureau projects a U.S. population of 417 million in 2060, which is a 38%

increase from 2007 (301.3 million). However, the United Nations projects a U.S. population

of 402 million in 2050, an increase of 32% from 2007. In an official census report, it was

reported that 54.4% (2,150,926 out of 3,953,593) of births in 2010 were non-Hispanic white.

This represents an increase of 0.34% compared to the previous year, which was 54.06%.

2.3.3 ECONOMY OF USA

The United States is the world's largest national economy in nominal terms and second

largest according to purchasing power parity (PPP), representing 22% of nominal global GDP

and 17% of gross world product (GWP). The United States' GDP was estimated to be

$17.914 trillion as of Q2 2015. The U.S. dollar is the currency most used in international

transactions and is the world's foremost reserve currency, backed by its science and

technology, its military, the full faith of the US government to reimburse its debts, its central

role in a range of international institutions since World War II and the petrodollar system.

Several countries use it as their official currency, and in many others it is the de facto

currency. The United States has a mixed economy and has maintained a stable overall GDP

growth rate, a moderate unemployment rate, and high levels of research and capital

investment. Its seven largest trading partners are Canada, China, Mexico, Japan, Germany,

South Korea, and the United Kingdom.

The US has abundant natural resources, a well-developed infrastructure, and high

productivity. It has the world's ninth-highest per capita GDP (nominal) and tenth-highest per

capita GDP (PPP) as of 2013. Americans have the highest average household and employee

income among OECD nations, and in 2010 had the fourth highest median household income,

down from second highest in 2007. It has been the world's largest national economy (not

including colonial empires) since at least the 1890s.

The U.S. is the world's third largest producer of oil and natural gas. It is one of the largest

trading nations in the world as well as the world's second largest manufacturer, representing a

fifth of the global manufacturing output. The US not only has the largest internal market for

goods, but also dominates the trade in services. US total trade amounted to $4.93T in 2012.

Of the world's 500 largest companies, 128 are headquartered in the US.

The United States has one of the world’s largest and most influential financial markets. The

New York Stock Exchange is by far the world's largest stock exchange by market

21

capitalization. Foreign investments made in the US total almost $2.4 trillion, while American

investments in foreign countries total over $3.3 trillion. The economy of the U.S. leads in

international ranking on venture capital and Global Research and Development funding.

Consumer spending comprises 71% of the US economy in 2013. The United States has the

largest consumer market in the world, with a household final consumption expenditure five

times larger than Japan's. The labour market has attracted immigrants from all over the world

and its net migration rate is among the highest in the world. The U.S. is one of the top-

performing economies in studies such as the Ease of Doing Business Index, the Global

Competitiveness Report, and others.

The US economy went through an economic downturn following the financial crisis of 2007–

08, with output as late as 2013 still below potential according to the Congressional Budget

Office. The economy, however, began to recover in the second half of 2009, and as of

November 2015, unemployment had declined from a high of 10% to 5%.

In December 2014, public debt was slightly more than 100% of GDP. Domestic financial

assets totalled $131 trillion and domestic financial liabilities totalled $106 trillion.

2.4 CANADA

Canada is a country in the northern half of North America. Its ten provinces and three

territories extend from the Atlantic to the Pacific and northward into the Arctic Ocean,

covering 9.98 million square kilometres (3.85 million square miles), making it the world's

second-largest country by total area and the fourth-largest country by land area. Canada's

border with the United States is the world's longest land border. The majority of the country

has a cold or severely cold winter climate, but southerly areas are warm in summer. Canada is

sparsely populated, the majority of its land territory being dominated by forest and tundra and

the Rocky Mountains. It is highly urbanized with 82 per cent of the 35.15 million people

concentrated in large and medium-sized cities, many near the southern border. One third of

the population lives in the three largest cities: Toronto, Montreal and Vancouver. Its capital is

Ottawa, and other major urban areas include Calgary, Edmonton, Quebec City, Winnipeg and

Hamilton.

Various aboriginal peoples had inhabited what is now Canada for thousands of years prior to

European colonization. Beginning in the 16th century, British and French claims were made

on the area, with the colony of Canada first being established by the French in 1534. As a

22

consequence of various conflicts, Great Britain gained and lost territories within British

North America until it was left, in the late 18th century, with what mostly geographically

comprises Canada today. Pursuant to the British North America Act, on July 1, 1867, the

colonies of Canada, New Brunswick, and Nova Scotia joined to form the semi-autonomous

federal Dominion of Canada. This began an accretion of provinces and territories to the

mostly self-governing Dominion to the present ten provinces and three territories forming

modern Canada.

In 1931, Canada achieved near total independence from the United Kingdom with the Statute

of Westminster 1931, but at the time, Canada decided to allow the British Parliament to

temporarily retain the power to amend Canada's constitution, on request from the Parliament

of Canada. With the Constitution Act 1982, Canada took over that authority (as the

conclusion of Patriation), removing the last remaining ties of legal dependence on the

Parliament of the United Kingdom, giving the country full sovereignty.

Canada is a federal parliamentary democracy and a constitutional monarchy, with Queen

Elizabeth II being the head of state. The country is officially bilingual at the federal level. It

is one of the world's most ethnically diverse and multicultural nations, the product of large-

scale immigration from many other countries. Its advanced economy is the eleventh largest in

the world, relying chiefly upon its abundant natural resources and well-developed

international trade networks. Canada's long and complex relationship with the United States

has had a significant impact on its economy and culture.

Canada is a developed country and has the tenth highest nominal per capita income globally

as well as the ninth highest ranking in the Human Development Index. It ranks among the

highest in international measurements of government transparency, civil liberties, quality of

life, economic freedom, and education. Canada is a Commonwealth realm member of the

Commonwealth of Nations, a member of the Francophonie, and part of several major

international and intergovernmental institutions or groupings including the United Nations,

the North Atlantic Treaty Organization, the G8, the Group of Ten, the G20, the North

American Free Trade Agreement and the Asia-Pacific Economic Cooperation forum. Canada

is an influential nation in the world, primarily due to its inclusive values, years of prosperity

and stability, stable economy, and efficient military.

23

2.4.1 GEOGRAPHY OF CANADA

The geography of Canada describes the geographic features of Canada, the world's second

largest country in total area.

Situated in northern North America (constituting 41% of the continent's area), Canada spans

a vast, diverse territory between the North Pacific Ocean to the west and the North Atlantic

Ocean to the east and the Arctic Ocean to the north (hence the country's motto "From sea to

sea"), with the United States to the south (contiguous United States) and northwest (Alaska).

Greenland is to the northeast; off the southern coast of Newfoundland lies Saint-Pierre and

Miquelon, an overseas collectively of France. Since 1925, Canada has claimed the portion of

the Arctic between 60°W and 141°W longitude to the North Pole; however, this claim is

contested. While the magnetic North Pole lies within the Canadian Arctic territorial claim as

of 2011, recent measurements indicate it is moving towards Siberia.

Covering 9,984,670 km2 or 3,855,100 sq mi (land: 9,093,507 km2 or 3,511,023 sq mi;

freshwater: 891,163 km2 or 344,080 sq mi), Canada is slightly less than three-fifths as large

as Russia and slightly smaller than Europe. In total area, Canada is slightly larger than both

the U.S. and China; however, Canada ranks fourth in land area (i.e. total area minus the area

of lakes and rivers)—China is 9,326,410 km2 (3,600,950 sq mi) and the U.S. is 9,161,923

km2 (3,537,438 sq mi)[3]

The population of Canada, some 35,749,600 as of April 2015, is concentrated in the south in

proximity to its border with the contiguous U.S.; with a population density of 3.5 people per

square kilometre (9.1/sq mi), it is one of the most sparsely populated countries in the world.

The northernmost settlement in Canada—and in the world—is Canadian Forces Station

(CFS) Alert (just north of Alert, Nunavut) on the northern tip of Ellesmere Island at 82°30′N

62°19′W, just 834 kilometres (518 mi) from the North Pole.

2.4.2 DEMOGRAPHICS OF CANADA

The last century has seen vast changes in Canada's population. With the notable exception of

the post-war baby boom (1946 to 1965), there has been a steady decline in fertility,

accompanied by a decrease in the death rate and an increase in life expectancy. These

changes resulted in the aging of Canada's population. Evidence of this demographic transition

can be seen in the median age of Canadians, that is, the age that divides the population in

24

half. In 1956, the median age in Canada was 27.2 years1. It climbed to 39.5 in 20062 and is

projected to reach 46.9 by 20561.

Three indicators illustrate the aging of Canada's population: life expectancy, population

composition (based on population estimates), and demographic dependency ratios. Life

expectancy reflects mortality, and therefore, levels of health and disease in the population.

As in other developed countries, life expectancy has increased in Canada and is projected to

continue to rise. In 2005, life expectancy was 78.0 years for males and 82.7 years for

females3. This marks substantial gains since 1956 when life expectancy was 67.7 years and

73.0 years for males and females, respectively4 and according to projections (based on a

medium mortality assumption), males born in 2031 will have an average life expectancy of

81.9 years, and females, 86.0 years1.

The composition of Canada's population also reflects the demographic shift to an older

population with seniors accounting for an ever-increasing proportion of the population. In

2006, 13.7% of Canadians were 65 or older, up from 7.7% in 19562. It is projected that by

2056 seniors will comprise between 25% and 30% of the Canadian population5. While the

proportion of seniors is increasing, children and young people comprise a decreasing portion

of the Canadian population. Mid last century, those aged 19 or younger made up 37% of the

population compared with 24% in 20066. It is projected that the proportion of youth in

Canada will continue to decline.

2.4.3 ECONOMY OF CANADA

Canada has the 10th (nominal) or 15th-largest (PPP) economy in the world (measured in US

dollars at market exchange rates), is one of the world's wealthiest nations, and is a member of

the Organization for Economic Co-operation and Development (OECD) and Group of Seven

(G7). As with other developed nations, the Canadian economy is dominated by the service

industry, which employs about three quarters of Canadians. Canada is unusual among

developed countries in the importance of the primary sector, with the logging and oil

industries being two of Canada's most important. Canada also has a sizable manufacturing

sector, based in Central Canada, with the automobile industry and aircraft industry being

especially important. With a long coastline, Canada has the 8th largest commercial fishing

and seafood industry in the world. Canada is one of the global leaders of the entertainment

software industry.

25

With the exception of a few big island nations in the Caribbean, Canada is the only major

parliamentary democracy in the western hemisphere. As a result, Canada has developed its

own social and political institutions, distinct from most other countries in the world. Though

the Canadian economy is closely integrated with the American economy, it has developed

unique economic institutions.

The Canadian economic system generally combines elements of private enterprise and public

enterprise. Many aspects of public enterprise, most notably the development of an extensive

social welfare system to redress social and economic inequities, were adopted after the end of

World War Two in 1945.

Canada has a private to public (Crown) property ratio of 60:40 and one of the highest levels

of economic freedom in the world. Today Canada closely resembles the U.S. in its market-

oriented economic system and pattern of production. As of February 2013, Canada's national

unemployment rate stood at 7.0%, as the economy continues its recovery from the effects of

the financial crisis of 2007–08. In May 2010, provincial unemployment rates varied from a

low of 5.0% in Saskatchewan to a high of 13.8% in Newfoundland and Labrador. According

to the Forbes Global 2000 list of the world's largest companies in 2008, Canada has 69

companies in the list, ranking 5th next to France.

2.5 JAPAN

Japan) is a sovereign island nation in Eastern Asia. Located in the Pacific Ocean, it lies off

the eastern coast of the Asia Mainland (east of China, Korea, Russia) and stretches from the

Sea of Okhotsk in the north to the East China Sea and Taiwan in the southwest.

Japan is a stratovolcanic archipelago consisting of about 6,852 islands. The four largest are

Honshu, Hokkaido, Kyushu and Shikoku, which make up about ninety-seven percent of

Japan's land area and often are referred to as home islands. The country is divided into 47

prefectures in eight regions. Hokkaido being the northernmost prefecture and Okinawa being

the southernmost one. The population of 127 million is the world's tenth largest. Japanese

people make up 98.5% of Japan's total population. Approximately 9.1 million people live in

the core city of Tokyo, the capital of Japan.

Archaeological research indicates that Japan was inhabited as early as the Upper Paleolithic

period. The first written mention of Japan is in Chinese history texts from the 1st century AD.

26

Influence from other regions, mainly China, followed by periods of isolation, particularly

from Western Europe, has characterized Japan's history. From the 12th century until 1868,

Japan was ruled by successive feudal military shoguns who ruled in the name of the Emperor.

Japan is a member of the UN, the OECD, the G7, the G8, and the G20 and is considered a

great power. The country has the world's third-largest economy by nominal GDP and the

world's fourth-largest economy by purchasing power parity. It is also the world's fourth-

largest exporter and fourth-largest importer. The country benefits from a highly skilled

workforce and is among the most highly educated countries in the world, with one of the

highest percentages of its citizens holding a tertiary education degree.

Although Japan has officially renounced its right to declare war, it maintains a modern

military with the world's eighth-largest military budget, used for self-defense and

peacekeeping roles. Japan is a developed country with a very high standard of living and

Human Development Index. Its population enjoys the highest life expectancy and the third

lowest infant mortality rate in the world.

2.5.1 GEOGRAPHY OF JAPAN

Japan is an island nation in East Asia comprising a stratovolcanic archipelago extending

along the continent's Pacific coast. It lies between 24° to 46° north latitude and from 123° to

146° east longitude. Japan is southeast of the Russian Far East, separated by the Sea of

Okhotsk; slightly east of Korea, separated by the Sea of Japan; and east-northeast of China

and Taiwan, separated by the East China Sea. The closest neighboring country to Japan is the

Russian Federation. The major islands, sometimes called the "Home Islands", are (from north

to south) Hokkaido, Honshu (the "mainland"), Shikoku and Kyushu. There are 6,852 islands

in total,[2] including the Nansei Islands, the Nanpo Islands and islets, with 430 islands being

inhabited and others uninhabited. In total, as of 2006, Japan's territory is 377,923.1 km2

(145,916.9 sq mi), of which 374,834 km2 (144,724 sq mi) is land and 3,091 km2 (1,193 sq

mi) water.

2.5.2 DEMOGRAPHICS OF JAPAN

The demographic features of the population of Japan include population density, ethnicity,

education level, health of the populace, economic status, religious affiliations and other

aspects regarding the population.

27

Based on the census from October 2010, Japan's population was at its peak at 128,057,352.

As of October 1, 2015, the population was 127,094,745 making it the world's tenth-most

populous country at the time. It had declined by 0.8 percent from the time of the census five

years ago, the first time it had declined since the 1945 census. Mexico's population was

slightly less than Japan's in 2015, with projections suggesting Mexico will soon pass Japan.

Current statistics do not indicate much difference in population numbers. Japan's population

size can be attributed to high growth rates experienced during the late 19th and early 20th

centuries.

Since 2010, Japan has experienced net population loss due to falling birth rates and almost no

immigration, despite having one of the highest life expectancies in the world, at 85.00 years

as of 2016 (it was 81.25 as of 2006. Using the annual estimate for October of each year, the

population peaked in 2008 at 128,083,960 and had fallen 285,256 by October 2011. Japan's

population density was 336 people per square kilometre.

Based on 2012 data from the National Institute of Population and Social Security Research,

Japan's population will keep declining by about one million people every year in the coming

decades, which will leave Japan with a population of 42 million in 2110. By that time, more

than 40% of the population is expected to be over age 65 in 2060. In 2012, the population had

for six consecutive years declined by 212,000, the largest drop on record since 1947 and also

a record low of 1.03 million births. In 2014, a new record of population drop happened with

268,000 people. In 2013, more than 20 percent of the population are age 65 and over.

The population ranking of Japan dropped from 7th to 8th in 1990, to 9th in 1998, and to 10th

in the early 21st century. In 2015 it dropped further to 11th place, according to both the UN

and PRB. Over the period of 2010–2015, the population shrank by almost a million.

Japan's population density was 336 people per square kilometre (874 people per square mile)

according to the UN World Populations Prospects as of July 2005. It ranks 37th in a list of

countries by population density, ranking directly above India (336 per km2) and directly

below Belgium (341 per km2). Between 1955 and 1989, land prices in the six largest cities

increased 15,000% (+12% a year). Urban land prices generally increased 40% from 1980 to

1987; in the six largest cities, the price of land doubled over that period. For many families,

this trend put housing in central cities out of reach.

28

Japan has a high population concentration in urban areas on the plains since 75% of Japan’s

land area is made up of mountains, and also Japan has a forest cover rate of 68.5% (the other

developed countries with such a high forest cover percentage are only Finland and Sweden).

The 2010 census shows 90.7% of the total Japanese population live in cities.

2.5.3ECONOMY OF JAPAN

The economy of Japan is the third-largest in the world by nominal GDP and the fourth-largest

by purchasing power parity (PPP). and is the world's second largest developed economy.

According to the International Monetary Fund, the country's per capita GDP (PPP) was at

$37,519, the 28th highest in 2014, down from the 22nd position in 2012. Japan is a member

of the G7. The Japanese economy is forecasted by the Quarterly Tankan survey of business

sentiment conducted by the Bank of Japan. Nikkei 225 presents the monthly report of top

Blue chip (stock market) equities on Japan Exchange Group. Due to a volatile currency

exchange rate, Japan's GDP as measured in dollars fluctuates widely. Accounting for these

fluctuations through use of the Atlas method, Japan is estimated to have a GDP per capita of

around $38,490.

Japan is the world's third largest automobile manufacturing country, has the largest

electronics goods industry, and is often ranked among the world's most innovative countries

leading several measures of global patent filings. Facing increasing competition from China

and South Korea, manufacturing in Japan today now focuses primarily on high-tech and

precision goods, such as optical instruments, hybrid vehicles, and robotics. Besides the Kantō

region, the Kansai region is one of the leading industrial clusters and manufacturing centres

for the Japanese economy. Japan is the world's largest creditor nation Japan generally runs

an annual trade surplus and has a considerable net international investment surplus. As of

2010, Japan possesses 13.7% of the world's private financial assets (the third largest in the

world) at an estimated $13.5 trillion. As of 2015, 54 of the Fortune Global 500 companies are

based in Japan, down from 62 in 2013.

Japan has the highest ratio of public debt to GDP of any developed nation. The Japanese

economy faces considerable challenges posed by a dramatically declining population.

Statistics showed an official decline for the first time in 2015, while projections suggest that

it will continue to fall from 127 million down to below 100 million by the middle of the 21st

century.

29

2.6 CONCLUSION

From the above discussion, it is evident that the selected countries i.e. India, USA,

Canada and Japan are equally competent on the basis of their geography, demography and

economy. Hence, comparative study of these countries worth a lot.

30

CHAPTER 3

REVIEW OF LITERATURE

31

CHAPTER 3: REVIEW OF LITERATURE


There are many studies that have been conducted both in our country and overseas to

measure the cointegration between Indian Market and foreign markets. hence the present

chapter has been undertaken with the following objectives:

1. To review the existing extant literature on studies conducted in the past to measure the

cointegration between Indian Market and foreign markets

2. To develop the research questions out of review of extant literature.

3.2 REVIEW OF LITERATURESince the influential work of Engle and Granger (1987), cointegration has emerged as a

powerful technique for investigating common trends in multivariate time series, providing a

sound methodology for modelling both long run and short run dynamics in a system. The

interest in cointegration literature has increased significantly as a result of this work and has

given rise to other important contributions to the subject.

Ghosh et al (1999) purports that financial theory hypothesizes that in the long run, certain

pairs of financial time-series data are projected to move together. Ghosh et al also claim that

short run deviations will be brought back to equilibrium due to investors’ tastes and

preferences, market forces and government regulations. However, it is the understanding of

how these short-term movements are related to each other that will help to understand the

economic relationships between the markets in our study more completely.

Lucas (1997) and Alexander (1999) demonstrate applications of cointegration analysis in

their studies, in relation to trading strategies such as index tracking and arbitrage, as well as

to portfolio asset allocation. Lucas and Alexander suggest index tracking and portfolio

optimization based on cointegration rather than correlation alone may result in higher asset

returns. Accordingly, if Lucas and Alexander’s claim is valid, our study of cointegration

between the US and European markets could be used to assist in addressing index tracking

and portfolio optimization. Adding to the current literature in this area will provide for more

proof, for or against the use of cointegration in this manner from an international

diversification standpoint.

32

Maneschiold (2006) analyzed cointegration between Baltic stock markets and major

international stock markets, including UK, France, Germany, US and Japan. The

cointegration analysis indicated that German markets dominate the long-term relationship

with Baltic stock markets. Furthermore, the overall results suggest that international investors

can obtain a long term benefit from diversification due to the absence of cointegration of

Baltic and international capital markets. This study concentrated more on the emerging Baltic

Markets and their movements compared to the major international markets using

cointegration, whereas our study will focus on the US versus larger established European

Markets, incorporating data over the past 8 years.

Kasibhatla et al (2006) study cointegration between major West European stock markets

(CAC40, DAX30, FTSE100). Their findings supported the notion that there is cointegration

between the markets, and identified the CAC40 as being weakly exogenous. There can be

excess returns in the short term by diversifying internationally, however due to the long run

cointegration, Kasibhatla et al claim that there is no benefit of long-term international

portfolio diversification (between CAC40, DAX30, FTSE100). This study, to the best of our

research and knowledge, is the closest to our own focus area – namely, studies that have been

conducted with the major indices and their possible cointegration relationships. Kasibhatla et

al employ the Johansen Cointegration Methodology mainly because they found it was the

most common method used to study long-term cointegration relationships along with their

references to support this claim.

Another study closely related to our paper is Yang et al’s (2003) analysis of cointegration

between US and international stock markets over a 32 year sample period – Yang et al’s

finding was that there was no long-run pattern of cointegration. They do see an increase of

cointegration in the latter part of their sample period, but conclude that due to the weak

cointegration overall, there are diversification benefits to US investors from splitting their

equity portfolio between the countries studied. These results are based on analysis of the

larger markets including Japan, United Kingdom, and Germany. They did however find an

increasing integration between the US and many smaller markets. Their data consisted of

time-series from 1970 to 2001. Our study is data from 2001 to 2009 and as mentioned before,

during a time of changing capital markets, increased globalization, and a huge negative shock

to the markets (the Global Financial Crisis turmoil).

33

Allen and MacDonald (1995) analyzed the benefits of international diversification to

Australian investors, using monthly index data for 16 countries. Both the Engle-Granger

(1987) and Johansen (1988) cointegration tests were used to measure these diversification

benefits. As was the case in other selected studies such as Taylor and Tonks (1989) and Allen

and MacDonald (1995) found that different cointegration testing methods yielded different

results in certain cases. Also, evidence of cointegration between the analyzed data subsets

was found, indicating that there is little benefit to the investor by diversifying internationally.

Taylor and Tonks (1989) studied the impact of abolition of U.K. exchange controls, and the

effect of this on the integration of U.K. and overseas stock markets. They concluded that

there appears to be no long-run gain from diversification owing to the apparent increase in

the degree to which markets move together.

Fadhlaoui et al (2008) analyzed the short and long-run relationships between seven developed

equity markets (US, Canada, UK, France, Germany, Italy and Japan) with Czech-Republic,

Hungary and Poland to evaluate evidence of cointegration. As with our study, this was done

to identify potential international diversification benefits. In the short-term, it was found that

there was a lower level of cointegration between the aforementioned developed equity

markets, and those of Central Europe. This short-term analysis was performed using the

correlation matrix, whereas the latter long-term analysis employed the use of the Johansen

cointegration test. The Johansen test revealed no evidence of a long-term relationship

(cointegration) between the two groups of markets. It can therefore be said that the increased

financial integration between equity markets internationally has not detracted from the

potential diversification benefits available to investors in this particular market.

Bessler and Yang (2003) conducted a study into the dynamic structure of nine major stock

markets (Australia, Japan, Hong Kong, UK, Germany, France, Switzerland, USA and

Canada) using Johansen’s maximum-likelihood model, and found only one cointegrating

vector. They infer that the US market is the only stock market that has a long-term

contribution to the price levels in other markets.

Onay (2007) suggests that there are long-term diversification opportunities in Bulgaria and

Romania due to the lack of cointegration with the European Union. This study is

concentrated around the accession negotiations with the EU, and demonstrates the fact that

diversification benefits are negatively related to the underlying level of cointegration between

markets. Onay highlights the possible benefits of investing in those countries that are new

34

entrants or prospective entrants to the EU, due to their lack of cointegration with developed

markets, supporting possible effects of the European Union on cointegration.

3.3 RESEARCH QUESTION

From the review extant of literature, the following research question has been developed

under the present study:

1. India is financially integrated or at least in the process of getting financially integrated with

the financial markets of G7 countries (USA Canada, Japan)?

2. If yes, are there any empirical evidences?

35

CHAPTER 4

REAEARCH DESIGN

36

CHAPTER 4: REASEARCH DESIGN


The present chapter has been undertaken with the following objectives:

1. To narrate the set of research objectives.

2. To identify and explain in set of statistical tools to be used in the present study in order to

best satisfy the research objectives

4.2 REASEARCH OBJETIVES

From the review of literature, the following specific research objectives have been formed for

the present study:

1. To identify the financial markets of G7 countries (USA Canada, Japan) and the variables

best representing them.

2. To detect whether Indian financial market is integrated with the financial markets of G7

countries (USA Canada, Japan).

4.3 TYPE OF DATA USED

My sample period is January 1997 - December 2016. I use the following currencies: the

Japanese Yen, the US Dollar and the Canadian Dollar against the Indian Rupees. We have

acquired monthly data on the exchange rates from the International Monetary Fund (IMF).

For the interest rates, we use monthly LIBOR rates for the above currencies, with short

maturities. The LIBOR interest rates data can be accessed from the British Bankers

Association (BBA).

4.4 TYPE OF STATISTICAL TOOLS USED

The economic literature surrounding the co-movements of stock markets agrees on neither

the existence nor the extent of linkages between international stock markets. This can be

attributable to different choices of markets, sample periods, frequency of observations and

different methodologies. Furthermore, the literature surrounding cointegration analysis does

not include a study on the markets we are testing. However, reviews of past studies provide

37

us with insight, guidance and reasoning as to what cointegration methods should be used in

our study.

4.4.1 INTRODUCTION OF COINTEGRATION

Cointegration analysis can be used to evaluate the co-movement of a long-term asset

price within an equilibrium model. Firstly, cointegration analysis establishes a long term

relationship by calculating long-run equilibrium asset prices. Next, correlations within an

error correction model are estimated. Therefore, stochastic trends common to the respective

time series are found prior to the cointegration analysis.

If the cointegration analysis indicates that there is a cointegration vector, we infer that the

tested series will not drift apart in the long-term, and will revert to equilibrium levels

following any short-term drift that may take place. In the context of this study, the presence

of a cointegrating vector means that diversification benefits available to investors are

reduced. In contrast, if no cointegrating vector is found, we infer that diversifying a stock

portfolio amongst the markets in question does provide benefit.

Cointegration analysis was introduced by Engle and Granger in the early 1980s, with

improvements and additions made in subsequent years. Cointegration is a modelling

process that incorporates non-stationary with both long-term relationships and short-term

dynamics. To examine time series in financial data using cointegration, the time series in its

level form should be non-stationary and integrated of order 1, written as I(1). Integrated of

order 1 means the series becomes stationary after differentiating it once. Variables are said to

be cointegrated if they are I (1) and have a linear combination which is stationary without the

need to differentiate the data.

There are two main cointegration methods that have consistently been used throughout past

studies which are: 1) Engle-Grangers Two Step Estimation Method; and 2) Johansen’s

Maximum Likelihood Method using either the Trace Statistic and/or the Maximum

Eigenvalue Statistic.

In this study I use the Johansen’s Method due to reasons mainly relating to the shortfalls of

Engle-Grangers Two Step Estimation Method. The Two Step Estimation Method is very easy

to run, however it needs a larger sample size to avoid possible estimation errors and can only

be run on a maximum of two variables (Brooks 2008). It also doesn’t allow for hypothesis

38

testing on the cointegrating relationships themselves, unlike Johansen’s method (Brooks

2008). Since we are also examining a total of 4 markets, we want the ability to examine them

in a multivariate framework, allowing for the possible discovery of more than one

cointegrating vector, which the Engle-Granger Method cannot accomplish. In this situation,

Johansen’s Method better suits the data, due the fact that it can examine more than two test

variables, and can treat all test variables as endogenous.

4.4.2 UNIT ROOT TESTINGImplementing the Johansen’s Cointegration method involves some initial testing of the time

series to ensure I(1), in other words testing for unit roots. In order to validate this

characteristic in our time series data, we utilize two different unit root tests, the

Augmented Dickey-Fuller Test (ADF) and the Phillip-Perron Test (PP). In general, the ADF

and PP tests are consistent with each other; however we include both as to ensure accuracy

regarding the unit root conclusion. Our study will test each time series individually to ensure

non-stationary at the levels of the data, and also run the unit root tests on the first differences

to ensure I(1).

The PP test is very similar to the ADF test. The main reason we also conduct a PP test is

because the ADF test loses power for sufficiently large values of p, the number of lags

(Ghosh et al, 1999). It includes an automatic correction to the Dickey-Fuller process for auto-

correlated residuals (Brooks 2008). The PP test is a more comprehensive theory of unit root

non-stationary.

39

CHAPTER 5

DATA ANALYSIS & FINDINGS

40

CHAPTER 5: DATA ANALYSIS & FINDINGS

5.1 DATA ANALYSIS

This section details all results from the testing we conducted. All testing was conducted using

EViews 9.0 statistical software.

5.2 UNIT ROOT TESTING

The Augmented Dickey-Fuller (ADF) test shows for all 5 indices that the level data was non-

stationary; however stationary was reached after the first difference. As discussed in the

Methodology section, this means all of our data is integrated of order one, requirement for

Johansen’s cointegration analysis. Our test results are significant at the 1% significance level.

The Phillip-Perron (PP) test is also conducted in order to confirm the test results of the ADF

and ensure non-stationary of the indices. The PP test, like the ADF test, indicates significance

for all sample periods, rejecting the null hypothesis of stationary at the 1% level.

5.3 KEY FINDINGS – DESCRIPTIVE STATISTICS (India and all stock

indices)

41

Interpretation

• The skewness statistics of daily data whether found to be positive or negative, but are

less than 1 for all the indices indicating that the level data distribution is almost

symmetric.

• Kurtosis is less than three for all the indices during the period suggests that the

underlying data is platykurtic i.e. squat with short tails about the mean, which

indicates that the data is not normally distributed.

• Additionally the application of Jarque-Bera (JB) statistics calculated to test the null

hypothesis of normality in the data rejects the normality assumption at 1% level of

significance.

5.4 KEY FINDINGS – ADF & PP TEST IN LEVEL DATA

Interpretation

• In order to prove it statistically that the data are stationary, the Augmented Dickey

Fuller (ADF) Test for unit root has been conducted. And to verify the results of ADF

Test, the Philips and Peron (PP) Test of stationary has been conducted.

• Here, the ADF Test has been undertaken by considering the constant term as well as

the trend.

42

• From the application of ADF Test, we come to a conclusion that the level data of

selected stock indices are nonstationary and in order to verify the results the PP Test

has also been performed which gave similar results.

5.5 KEY FINDINGS – ADF & PP TEST - FIRST DIFFERENCE DATA

Interpretation

• But, when the ADF and PP Tests are again applied to the first differences of the

selected indices, they became stationary

• Hence, it implies that since all the selected indices are nonstationary in their level

form and are becoming stationary in their first difference, we may go for a test of

cointegration. We have selected the Engle Granger methodology for detecting

cointegration in this study.

5.6 KEY FINDINGS – TEST OF COINTEGRATION

43

Interpretation

• The coefficient for regression of BSE 30 on the selected indices is given and for all

the cases the p-value is 0.00. But there remains the symptom of spurious regression

here as the R-squared value in the respective cases is greater than Durbin-Watson

statistics. As the regression results are showing symptoms of spurious regression, if

the residuals of the model will be found stationary, then it would remain no longer

spurious, we can accept the model. If the residual of the model is found stationary, it

also mean that variables in the model are cointegrated or they have long-run

relationship or equilibrium relationship between them. India is not cointegrated with

any of the G7 countries’ indices (USA, CANADA & JAPAN).


Interpretation

• Here also it can be seen that India is not found cointegrated with any of the G7

countries’ indices (USA, CANADA & JAPAN).

5.8 KEY FINDINGS – DESCRIPTIVE STATISTICS (India and all

Exchange rates)

44

Stat

isti

c

BSE

30

CA

NA

DA

JAPA

N

USA

Mean 12587.02 40.24111 0.464353 48.98488Med 12153.17 39.258 0.41745 46.3975Max 29220.12 62.354 0.7151 68.598Min 2810.66 25.808 0.2939 35.7SD 8316.734 9.442554 0.106733 8.003061

Skew. 0.382026 0.338286 0.477518 1.038085Kurt. 1.837486 1.923368 2.121064 3.025754JB. 18.86835 15.6299 16.42507 42.03021

Prob. 0.00008 0.00404 0.000271 0Source: Compiled from E-Views Output

Table 5.6 Descriptive Statistics of Level Data

Interpretation



symmetric.






significance.


Interpretation





the trend.




45

5.10 KEY FINDINGS – ADF & PP TEST IN FIRST DIFFERENCE DATA

Interpretation








46

Interpretation








relationship or equilibrium relationship between them. Indian stock market is not

cointegrated with exchange rates of Indian rupees vis a vis G7 currencies (USA,

CANADA & JAPAN).


Interpretation

• Here also it can be seen that India is not found cointegrated with any of the G7

countries’ indices (USA, CANADA & JAPAN).

47

5.13 KEY FINDINGS – DESCRIPTIVE STATISTICS (India& LIBOR Rate)

Table 5.11 Descriptive Statistics of Level Data

Stat

isti

c IND

IA

LIB

OR

Mean 12587.02 2.519271Med 12153.17 1.678605Max 29220.12 6.79014Min 2810.66 0.22609SD 8316.734 2.249487Skew. 0.382026 0.49025Kurt. 1.837486 1.619065JB. 18.86835 27.96652Prob. 0.00008 0.000001Source: Compiled from EViews output

Interpretation



symmetric.






significance.


48

Computed Value

Critical Value at

5% Level P ValueComputed

Value

Critical Value at

5% Level P ValueINDIA -2.801 -3.429 0.1985 -3.046 -3.429 0.1221LIBOR -1.742 -3.429 0.7291 -1.803 -3.429 0.6999

Table 5.12: ADF & PP TEST RESULTS OF LEVEL DATAADF Test Results PP Test Results

Name

Note: Null Hypothesis: There is unit root. Alternative Hypothesis: There is no unit rootSource: Compiled from E Views Output

Interpretation





the trend.




5.15 KEY FINDINGS – ADF & PP TEST IN FIRST DIFFERENCE DATA

Interpretation







49

Computed Value

Critical Value at

5% Level P ValueComputed

Value

Critical Value at

5% Level P ValueINDIA -15.094 -3.429 0 -15.138 -3.429 0LIBOR -10.792 -3.429 0 -11.485 -3.429 0

Table 5.13: ADF & PP TEST RESULTS OF FIRST DIFFERENCE

Name

ADF Test Results PP Test Results

Note: Null Hypothesis: There is unit root. Alternative Hypothesis: There is no unit rootSource: Compiled from E Views Output


Interpretation








relationship or equilibrium relationship between them. Indian stock market is not

cointegrated with exchange rates of Indian rupees vis a vis LIBOR Rate.


Interpretation

• Here also it can be seen that India is not found cointegrated with LIBOR Rate.

50

Engle Granger Critical Value-5%

LIBOR -2266.61 0 0.3758 0.0218 -15.83 -3.34Note: ‘*’ :- Null Hypothesis that there is unit root is rejected. Source: Compiled from E Views Output

ADF Test Statistic

for Residual

Table 5.14: REGRESSION RESULTS WITH BSE 30 AS DEPENDENT VARIABLE

NAME

Coefficie

nt P ValueR Squared

ValueDW

Statistic

Engle Granger Critical Value-5%

LIBOR -2266.61 0 0.3758 0.0218 -15.83 -3.34

Note: ‘*’ :- Null Hypothesis that there is unit root is rejected. Source: Compiled from E Views Output

Table 5.15: REGRESSION RESULTS WITH BSE 30 AS INDEPENDENT VARIABLE

NAME

Coefficie

nt P ValueR Squared

ValueDW

Statistic

ADF Test Statistic

for Residual

CHAPTER 6

CONCLUSION & SUGGESTIONS

51

CHAPTER 6: CONCLUSION

From above study we found that India is not co- related with any of the G7 countries, so it is

not possible to do a financial integration with any of the G7 countries.

So it is not possible to do financial integration with G7 countries. Without financial

integration it is not possible to find out any relationship among them. And also India will not

able to be in G7 countries. Without financial integration there will not be any capital flow to

India. From above we found that G7 countries have surplus money to meet the financial

requirement, but India has deficit money.

So in order to meet the financial requirement India needs to develop its policies and rules. If

India wants to be in the list of G7 countries it should make its policy such that it should be

financially integrated with G7 countries.

52

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Important Websites

www.worldbank.org

www.yahoofinance.com

www.imf.org

www.wconomicimes.com

54

http://www.wconomicimes.com/

http://www.imf.org/

http://www.yahoofinance.com/

http://www.worldbank.org/

Economy & Finance

A COINTEGRATION STUDY AMONG SELECTED FINANCIAL MARKETS OF MAJOR G7 COUNTRIES (USA, JAPAN &CANADA), EXCHANGE RATES OF INDIA & LIBOR