Are there still portfolio diversification benefits in Eastern Europe? Aggregate versus sectoral stock market data

Abstract

The advent of the European Union has decreased the diversification benefits available from country based equity market indices in the region. This paper measures the increase in stock integration between the three largest new EU members (Hungary, the Czech Republic and Poland who joined in May 2004) and the Euro-zone. We allow for a potentially gradual change in correlation between stock markets, which seems particularly appropriate to analyse the increasing integration between the Eastern European and the Euro-zone stock markets over the recent years. At the country market index level all three Eastern European markets show a considerable increase in correlations in 2006. At the industry level the dates and transition periods for the correlations differ, and the correlations are lower although also increasing. The results show that sectoral indices in Eastern European markets may provide larger diversification opportunities than the aggregate market.