FINM7008 Farah Mehdi-U4482319

Title of Journal: International Market Correlation and Volatility

Author(s): Bruno Solnik, Cyril Boucrelle and Yann Lefur

Year of publication: 1996

Journal name, Volume and Pages: Financial Analyst Journal, 52(5), 17-34

The title of the journal clearly states that the article is about the relationship/ correlation
between the major international markets with the U.S. market and the volatility which comes along
with it. The author(s) go on to state that the article is not the first of its kind, with many articles
published before this on the same topic. But the author(s) go on to state that they want to address
two main questions, namely, The correlation between international market in past 30 years with the
growth in the international markets and if correlation increases in periods of high market volatility.
They further go on to answer their own questions by gathering data for 37 years from 1958 to 1995
for stocks and 36 years from 1959 to 1995 for bonds, this data is in the form of monthly data.

The foreign markets which the author(s) have used for this article are Germany, France, the
United Kingdom, Switzerland and Japan, these countries are taken, as explained by the author(s),
because they, together with the U.S. market represent 80% of world capitalization in any given point
and time at the time of the study. The article shows that the correlation fluctuates over time and
across the countries and do not follow the pattern of correlation between the countries and hence is
not the same. The author(s) go on to point that the stock market performance is clearly related to
the business cycle and the economic growth of the country, but other international markets do not
always follow the same timings of the business cycle or the economic growth as another country,
thus obviously not synchronized, this is one of the main reasons for the markets not correlating in
the same pattern, the same correlation pattern is applied for bonds as well. The graphs illustrate
most of the study and the experiments of the author(s) and any exceptional cases are explained, for
example the peaks or shocks in a graph can be attributed to the oil shocks or some global event
which may affect the markets. In one of the graphs the author(s) have fitted a simple least square
line over the total period of the study and have discovered that the largest slope is of the U.K. to
U.S., the correlation showing 0.115 percent monthly, which means the two countries correlation
goes up 1.38 percent a year, that’s 47 percent increase for the whole period taken for the study. The
main reason behind this correlation can be explained due to the opening up of the British markets
for foreign investments and foreign ownership, especially from United States. There is also a
currency correlation between France and Germany reaching .8 percent in the 1990’s; this can be
explained as the prelude to the single European currency planned in the Maastricht treaty. The
authors go on to warn that due to econometric problems the graph might be subject to error.

For the EAFE Index the correlation was 0.375 in December 1961, 0.636 in December 1969 and
0.390 at the end of 1995, but the simple fit of the trend line yields a negative slope of -0.00034 a
month, this means that the five major market have a non negative trend but EAFE index exhibits a
slightly negative one, this is because in the early years the index was dominated with the European

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FINM7008 Farah Mehdi-U4482319

markets and these markets are always more correlated with the U.S. markets as compared to the
Asian markets, but then the Asian market grew rapidly and that pushed down the correlation of the
U.S. market in the Index. Also the emerging markets are less correlated with the rest of the world,
this is explained in another article by Jean-Marc Sure and Jean-Claude Cosset called “Political risk
and benefits of international portfolio diversification”.

The author(s) explain that the volatilities of the markets tend to move together and the
correlation of the markets tends to follow movements in market volatilities, also explained is that
the changes in the U.S. volatility have more influence than their own national volatility. Global
shocks which take place affect all markets and their correlation and volatility at the same time. With
the globalization of the world economies the advantage of foreign diversification of investment
might lose its advantage due to the correlation between the markets, this will not allow the
investors to invest in another country if the market is down in their own home country. The
author(s) have used ex post analysis, which they claim complements the findings by Erb, Harvey and
Viskanta in 1994 which claimed something similar to the author(s) findings which is “high
international correlation is associated with high market volatility”. They concluded by saying that the
volatility is contagious across the markets.

The author(s) have also studied the bond market and it shows that the same way as the stock
market the bond market fluctuates largely over time. As in the case of the correlation between the
U.S. and U.K. market for bonds, there is an increase in correlation, this is again due to the opening up
of British market for foreign investments, mainly from the United States. The article shows that the
volatilities move in a concert and that international correlation increases in period of high volatility.
The author(s) point out that the U.S. bond market volatility does have a strong affect on the
correlation between foreign bond market and the U.S. bond market. However the bond and stock
market are not synchronized and thus the correlation in the international stock market do not affect
the international bond market and vice versa.

The article is well researched and also has many references the author(s) were able to use by the
previous articles on the same topic. The many graphs are an advantage as it allows a quick reference
without having to go through the whole article for specified information needed. But I do think that
there may have been a repetition of previous articles on the same topic due to the many references
made by the author(s). The article does put a little bit of fear regarding diversifying the portfolio into
foreign markets, due to some correlation between the markets, especially now due to the
globalization of almost all of the world market. A good paper for fast reference due to the many
graphs and tables.

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