Sectoral Equity Returns in the Euro Region: Is There any Room for Reducing the Portfolio Risk?

Abstract

The economic integration among Euro members has important consequences for the factors driving asset pricing and asset trading within the financial markets. In particular, since the start of the Euro, cross-country equity index correlations in the region have showed upward trends and domestic investors have allocated their portfolios mostly inside of the region. This paper studies the impact of these recent structural changes on the Euro-wide sectoral equity indices. We modeled the return and volatility of the Euro sector equity indices between years 1992 and 2007. We documented that aggregate world equity or global sector equity indices have not been affecting the sector equity indices since the beginning of the Euro. Aggregate Euro stock index, however, still has been affecting most of the sector equity indices, even though its effect has been declining remarkably for some sectors. In particular, we found that financial sector indices (financial services, insurance, and banking) are being affected increasingly by the aggregate Euro equity index fluctuations after the start of the Euro. However, some ``basic industry sector'' indices, including basic resources, food and beverage, health-care, retail services, and oil & gas had become less dependent to the aggregate Euro index within the same period, suggesting that diversification across these sectors within the region would be much more effective tool for reducing portfolio risk