A Dynamic Analysis of the Integration of the Korean Stock Market with Its Trading Partners

Abstract

This paper investigates whether foreign trade matter for the stock markets integration by segmenting Korean trade partners into three groups USA, China, and Japan based on bilateral trade relations. We further explore the time-varying correlations of pairwise stock market returns by employing DCC-GARCH models. The study uses daily stock price index data from January 2nd, 2006 to December 31st, 2018. Empirical findings show the presence of a long-run relationship between Korea and its major trading partners in the pre-crisis and post-crisis (includes crisisperiod). Results from DCC-GARCH evidence that correlations are time-varying and increase significantly during the crisis period and revert close to their initial levels after the crisis. Further, we also find that the time-varying correlations of Korea with the USA and Japan are more volatile. Our findings confirm that foreign trade intensity matters for the stock market integration. The absence of a stable long-run relationship may provide an incentive for investors to include these markets into their portfolio selection process to exploit potential diversification benefits.