Comovements and stock market integration between India and its top trading partners: A multivariate analysis of international portfolio diversification

It has been documented that strong (weak) comovements between stock markets provide less (more) diversification for investors. Comovements in stock markets can be contributed to asset pricing theory and the influence of macroeconomic variables. This study seeks to determine empirically if investors can diversify their portfolios by investing in Indian stock markets and the stock markets of its top trading partners. India's top trading partners in recent years have been China, the United States, Israel, Malaysia, Germany, Singapore, UK, Hong Kong, Switzerland, and the Netherlands. This dissertation studies a sample of monthly stock market returns in order to answer the following null hypotheses. There is no linear relationship between Indian stock market returns and the stock market returns of its top trading partners. Investors cannot achieve cross-country diversification by investing in the Indian stock market and the stock markets of its top trading partners. Indian stock market returns do not share a geographical association with its top trading partners. Principle component analysis is used to examine the hypotheses. The results of the principle component analysis lead to a rejection of the following null hypotheses and an acceptance of the alternative hypotheses. A linear relationship does exist between Indian stock returns and the stock returns of its top trading partners. Investors can achieve cross-country diversification by investing in the Indian stock market and the stock markets of its top trading partners, and Indian stock returns do share a geographical association with its top Asian trading partners. The implication is that an astute investor can diversify his or her portfolio to achieve higher expected returns and lower overall risk, by investing in Indian stock market and the stock markets of its top trading partners.