National Output and Market Return Integration of G-7 Countries: A Perspective from Principal Component Analysis

Abstract

This study explores the evolution of integration in output trends, cycles, and market returns for G-7 countries. We use unobserved component model to decompose national output levels and identify quantitatively significant trend and cycle components. For all countries, trend components dominate both in terms of magnitude and importance due to the permanent nature of the shocks they capture. Using principal component analysis, we reveal the existence of common factors driving the volatility in trends, cycles, and market returns. A central contribution of our work is the construction of quantifiable measures of output trend, cycle, and market return integration, referred to as indices of integration. Our indices display high volatility with no trend. In addition, a null hypothesis for white noise could not be rejected for the trend and cycle integration indices. Our study is not able to establish a relationship between integration and national output and market return levels.