Determinant of stock market return correlation: An extended gravity model approach

Abstract

During the last several years a large number of studies have expressed increasing concerns regarding to importance of stock market correlation across the countries due to diversification problem. Most of the empirical studies try to measure correlation between stock market returns across countries without questioning that what drives correlation. The main objective of this study is to investigate the determinant of correlation between Istanbul Stock Exchange (ISE) return and stock market returns for selected countries over the 1991:1–2006:12 period by employing the extended gravity model with a panel regression econometric technique. This study departure from previous studies in two ways. First, study focuses on determinant of correlation between ISE return and selected 39 developed and developing countries from different regions. Second, two new variables (level of democracy and European Union (EU) membership) used to explain correlation between ISE return and return of selected countries stock market. Result from panel data regression showed that ISE is more correlated with democratic countries stock market. Also, if there is volatility in world stock markets return, correlation between ISE and selected stock market returns will increase