Whether economic interdependence among countries is a contributing factor to co-integration and common stochastic trends in international stock markets is indiscernible due to conflicting results from prior empirical works. The purpose of this study is in two folds: Firstly to investigate whether the implementation of the Maastricht treaty has played any role in determining the long-run relationship between U.K stock market and other E.U and non-E.U stock markets and also to investigate the extent to which world stock markets have been correlated in the short-run over the study period and how such relationships would benefit investors in their portfolio diversification decisions. Data for this study was obtained from M.S.C.I indices and covered the period from 1985-2003. The methodologies used for this study are the correlation coefficient, the Vector Error Correction model and Vector Autoregressive model for the short-run relationship as well as the Johansen Co-integration approach for testing the long-run stochastic trend among the variables under consideration. The results for the short-run relationship among the variables indicates that in general, stock markets from the developed economies have become integrated in the short-run after the implementation of the Maastricht treaty compared to the pre-Maastricht treaty era. The results also show that the U.K stock market shows high correlation with the U.S stock market both before and after the implementation of the treaty and that correlation with other European Union economies, increased after the treaty. The co-integration results for the pre-Maastricht treaty period showed 2 co-integrations among the variables but there was no evidence of co-integration after the implementation of the treaty. However, when test was carried out for the whole study period, the results showed 1 co-integration among the sample country indices. The implication from the above results shows that diversification benefits for international investors wishing to invest into these developed markets especially in the short-run should expect reduced gains. However, long-term diversification benefits are possible as long as the correlations between these markets are low.
Keywords: Co-integration, European Union., Maastricht Treaty, Portfolio Diversification, Stock Market
