A Long-Term Relationship Between Sri Lankan Stock Market and Global Stock Markets: A Time Series Analysis

Abstract

A stock market plays a vital role in the capital generation of a nation. With increased financial integration, factoring the regional and international dynamics shared in stock markets assist investors in portfolio diversification decisions and assist policy makers in implementing appropriate policies during a turmoil period. Thus, the study intended to identify the dynamic relations of the Colombo Stock Exchange (CSE) with other prominent global markets to provide insights in making appropriate investment and policy decisions. The study analysed the daily returns of All Share Price Index (ASPI), the broad market index of Sri Lanka and six international stock markets of US, UK, China, Japan, Germany, and India from May 1992 to December 2020. Owing to the non-stationarity of data, a Vector Error Correction Model (VECM) was developed. The stationarity and the presence of cointegration among ASPI and all selected stock markets were identified except the Chinese stock market. German and Indian stock markets were negatively integrated with ASPI in the long run contrasting to the Japanese, US, and UK stock markets positively cointegrated with ASPI. The study provided evidence for trade links and national level trade and cooperation leading to higher market integrations. Furthermore, the study extended the empirical evidence on geographically and economically closer countries being highly integrated in the long-term. Therein, on contrary to previous studies, study identified that CSE as a frontier market gets affected by larger stock markets in the long run. Hence, study insights were imperative in investor and policymaker decisions on the long run relations present among ASPI and the selected stock markets.