(I)rationality of Investors on Croatian Stock Market – Explaining the Impact of American Indices on Croatian Stock Market

Abstract

This study aims to detect and explain co-movements and spill over effects between American and Croatian stock markets. Following the methodology and findings of Erjavec and Cota (2007), the dependency of the Crobex index to the main US indices (DJIA, S&P500, NASDAQ) is further examined. The econometric study is widened, and the persistent relationship between Croatian and American indices is additionally elaborated using ARIMA and GARCH models using a different data set (January 3rd, 2005 to November 6th, 2008). Despite the fact that intra-sectoral connections between Croatian and American business sectors are rather weak, it is clear that the investors on the Croatian stock market dominantly rely on American indices movements. This was especially apparent during the beginning of the World Financial Crisis in October 2008 when the prices of Croatian companies had almost nothing to do with their business results. The behaviour of Croatian investors was largely based on the psychological effects of the crisis, and this is why behavioural finance is introduced to explain what pure financial reasoning could not. High correlation and co-movements between Croatian and American indices could be explained by three concepts; global factors, contagion and irrational escalation.ARIMA, GARCH, Crobex, Zagreb Stock Exchange, financial crisis, behavioural finance