Financial Integration for India Stock Market, a Fractional Cointegration Approach

The Indian stock market is one of the earliest in Asia being in operation since 1875, but remained largely outside the global integration process until the late 1980s. A number of developing countries in concert with the International Finance Corporation and the World Bank took steps in the 1980s to establish and revitalize their stock markets as an effective way of mobilizing and allocation of finance. In line with the global trend, reform of the Indian stock market began with the establishment of Securities and Exchange Board of India in 1988. This paper empirically investigates the long-run equilibrium relationship and short-run dynamic linkage between the Indian stock market and the stock markets in major developed countries (United States, United Kingdom and Japan) after 1990 by examining the Granger causality relationship and the pairwise, multiple and fractional cointegrations between the Indian stock market and the stock markets from these three developed markets. We conclude that Indian stock market is integrated with mature markets and sensitive to the dynamics in these markets in a long run. In a short run, both US and Japan Granger causes the Indian stock market but not vice versa. In addition, we find that the Indian stock index and the mature stock indices form fractionally cointegrated relationship in the long run with a common fractional, nonstationary component and find that the Johansen method is the best reveal their cointegration relationship.unit root test, cointegration, Error Correction Model, Vector Autoregression Model, Johansen Multivariate Cointegration, Fractional Cointegration