A Time-Varying Parameter Model to Test for Predictability and Integration in the Stock Markets of Transition Economies Author(s): Michael

Rockinger and Giovanni Urga Reviewed work(s): Source: Journal of Business & Economic Statistics, Vol. 19, No. 1 (Jan., 2001), pp. 73-84 Published by: American Statistical Association Stable URL: http://www.jstor.org/stable/1392543 . Accessed: 15/01/2013 06:24
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Model Parameter Time-Varying and Integrationin Predictability Markets of Transition

to

Test

for

the

Stock

Economies

Michael ROCKINGER

France(rockinger@hec.fr) 78351 Jouy-en-Josas, of Finance, HEC-School of Management, Department

Giovanni URGA

BusinessSchool, Department of Investment, RiskManagement and Insurance, CityUniversity Frobisher 8HB,UnitedKingdom Centre,LondonEC2Y Crescent,Barbican (g.urga@city.ac.uk)
This article introduces a model, based on the Kalman-filterframework,that allows for time-varying parameters, latent factors, and a general generalized autoregressive conditional heteroscedasticity (GARCH) structurefor the residuals.With this extension of the Bekaertand Harvey model, it is possible to test if an emerging stock marketbecomes more efficient over time and more integratedwith other already established marketsin situations in which no macroeconomicconditioning variablesare available. We apply this model to the Czech, Polish, Hungarian,and Russian stock markets.We use data at daily frequencyrunningfrom April 7, 1994, to July 10, 1997. A latent factor capturesmacroeconomic measuredwith time-varyingautocorrelations, Hungaryreached expectations.Concerningpredictability, efficiency before 1994. Russia shows signs of ongoing convergencetowardefficiency. For Poland and the Czech Republic, we find no improvements.With regard to market integration,there is evidence that the importanceof Germanyhas changed over time for all markets.Shocks in the United Kingdom are positively related to the Czech and Polish marketsbut not to the Russian or the Hungarianmarkets. Shocks in the United States have no impact on these marketswith the exception of Russia. A strong negative correlationbetween Russia and the United States and Germanytends to disappearover the time span studied. We also show that these marketsexhibit significantasymmetricGARCH effects where bad news generatesgreatervolatility.In Hungary,good news, instead,generatesgreatervolatility, which leads us to formulatea liquidityhypothesis. KEY WORDS: Central and Eastern Europe; Kalman filter; Market integration; Stock indexes; Volatility transmission.

There is a set of interesting new stock markets that have emerged out of the former communist bloc and that have been little investigated in the literature.Because these markets are even newer than other emerging Asian or South American markets (already studied extensively by Bekaert 1995; Claessens, Dasgupta, and Glen 1995; Bekaert and Harvey 1997; among others), and also because of their economic and culturaldifferences from the other newer markets, it appearsinterestingto gain insight into the working and evolution of these countries' financial markets. In our study we focus on a sample of Centraland EasternEuropeanFinancial Markets (CEEFM)--namely, the Czech, Hungarian, Polish, and Russian markets. The methodologicalcontributionof this article is the introduction of a model that allows for latent factors, time-varying parameters,and a general generalized autoregressiveconditional heteroscedasticity(GARCH) structurefor the residuals, extending the Bekaert and Harvey (1997) model. The basic frameworkused in this article is the Kalman filter. The use of a model with latent factors is motivatedby the observation that, unlike in the main related works such as those of Harvey (1995) and Bekaertand Harvey (1995, 1997), for the countries in our panel, very little informationbeyond the level of stock indexes is available.Typically,dataare available only for a few years for these countries. It is therefore unreasonableto use data at a monthly frequencyas is done in other studies of this type because the sample is just too small.
73

the macroeconomicdata is of doubtful quality. Furthermore, We would like to emphasize the fact that, even if longer time series of macroeconomicvariableswere available,our model would allow the captureof unobservablevariables. The fact that our model allows for time-varyingparameters further allows us to address two importanteconomic questions: (1) Have the CEEFMbecome more efficient over time, and (2) did they become more integratedwith other already establishedmarkets? First, the markets under investigation are very young and have emerged out of centrally planned economies. One can expect that these markets,to attractforeign capital, have tried to adapt their standardsto internationalstandardsby improving disclosure practices of firms, order execution, and ownership rights and by bringing down limitations to international capital flows. As a consequence of these improvements,liquidity should improve. Moreover,apparentarbitrageopportunities due to autocorrelations in returnsshould disappear.We test if such changes take place by investigatingif predictability (measured throughtime-varyingautocorrelations)has indeed evolved over time. This correspondsto a test of a weak form of marketefficiency.

? 2001 American Statistical Association Journal of Business & Economic Statistics January 2001, Vol. 19, No. 1

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74

Journalof Business & EconomicStatistics,January2001

Second, for the investor interestedin internationaldiversification, the knowledge of a country'scorrelationwith worldwide risk is of primeimportance. Certainmodels have assumed perfectintegration,while othershave assumedsegmentationor partial segmentation.Bekaert and Harvey (1995, 1997) combined both extremes in a model allowing for time-varying integration, which they applied to a large set of emerging markets.Their work thereforeencompasses models in which marketsare assumed to be perfectly integrated(Solnik 1983; Harvey 1991; Ferson and Harvey 1993, 1994), perfectly segmented (Sharpe 1964; Lintner 1965), or constantlyin between (Errunzaand Losq 1985). We obtain time-varyingintegration Further, by assuming that we have time-changingparameters. we allow for geographicintegrationby investigatingthe impact of a few selected establishedstock markets(ESM) ratherthan by using a single world index. The set of ESM consists of the U.S. market (the largest capitalizationof the world), the U.K. market (the largest European capitalization), and the German market (geographical vicinity and importance as a tradepartner). Our model is also able to deal with very complex GARCH of such effects leads to an improved effects. The incorporation efficiency of estimates. This model is, therefore, of use in any situation in which there are time-varyingparametersand parametricheteroscedasticity in the residuals. Beyond this, for the study of marketintegration,country-specificGARCH effects are necessary to gauge the relative component in domestic volatility of foreign shocks. The GARCH effect that we consider allows for asymmetries. It is well documented (Campbell and Hentschel 1992) that for established markets bad news leads to subsequentincreased volatility. This is the so-called Black (1972) leverage hypothesis.The asymmetryin the GARCHprocess allows us to test if the CEEFMalso obey the leverage hypothesis. On the other hand, for those countries suffering from low liquidity, one can imagine scenarios in which good news can lead to increased liquidity, which in turncan lead to increasedvolatility as investorsrebalancetheir portfolios. We call this phenomenonthe liquidityhypothesis. The articleis organizedas follows. In Section 1 we describe the general model allowing for latent factors, time-varying parameters,and GARCH in the residuals. In Section 2 we provide descriptive statistics. We then report and discuss the results of the estimationof our model and test for integration, and the leverage-liquidityhypothesis. Section 3 predictability, presents our conclusions. 1. A GENERALMODELWITHTIME-EVOLVING AND INTEGRATION PREDICTABILITY In a recent articleon emergingmarkets,Bekaertand Harvey (1997)-BH henceforth-presented a very interestingframework within which it is possible to study whether markets evolve toward greater integration. In this article we extend their model by using the Kalman-filter approach,which allows us to deal explicitly with time-varyingcoefficients and a general GARCH structurefor the residuals. 1.1 Theoretical Framework

integration as in BH; rather than having one world index, we allow for a countrythat may geographicallydominate.Let this country be indexed by D. Its continuously compounded stock return at time t is denoted by ro,,. All returnsin this article are defined by the formula r, = 100.-In(S,/St_1), where St stands for the closing value of the index at time t. It is assumedthat the marketD has returnsthatevolve accordingto
= ro,D aD, tXD, t + E,t, aD,t
=

(1)

aD,
=

t-l

lo,,,

(2) (3)

ED,t

"D,tD, t,

and
2 0? P?E2,IL

D, t =

DDDt--1I D,t-l>0}

{ot

O} +

31

2 , t 1,

(4)

where aD, t and D, represent,respectively,a time-varyingvecmatrixallowing for possibly and a parameter tor of parameters in the behavior parameters. autoregressive ZD,t and roD,,represent random noises, assumed to be distributednormally with mean 0, and respective variances 1 and QD, . QD,t represents a square matrix with dimension the numberof rows of aD ,. The vector x, t correspondsto variablesthat are assumed to describe the conditional mean. Such variablesmay be lagged returns,seasonal dummies, or other predictingvariables-for example, see Taylor(1986) for possible seasonalities in stock returns.Since aD,t representsa vector, by setting an element in x, t equal to 1 we obtain a model with a latentfactor.More integrated complicated latent structuressuch as autoregressive moving average(ARIMA) processes can also be implemented. The term aD,, tx,, in (1) is called the conditional mean. The residual ED,t is the unexplained part of the return of country D. For volatility we have chosen in Equation(4) a widely used GARCH(1,1) that allows for asymmetries. In the literature, various specificationsallowing for asymmetriescan be found-for example, Campbelland Hentschel(1992), Glosten, Jagganathan,and Runkle (1993), and Zakoian (1994). The parameters 3o, 13,/3o, 3o represent,respectively,a constant, the importance of positive shocks, the importance of negative shocks, and the importanceof persistence. "{condition} is a dummy variabletaking the value 1 whenevercondition is true and 0 otherwise. In Appendix A we show how the Kalman filter and the smoother can be adaptedto deal with GARCH effects. We emphasizethat this methodcan be appliedto other models, estimatedby the Kalmanfilter,where residualsfollow GARCH dynamics. We next consider a given country i, for which we wish to test predictabilityand time-varyingintegrationwith the dominant country D. We assume that returns' dynamics can be modeled as in the following, where the exponent between parenthesesrepresentsan index, not a power:
S= Ei,

a(2)
i D, t

+ e1,
i, t ,()

(6)

In testing for time variation of market integration, we focus on geographicalsegmentationratherthan on worldwide

r =--

= ei,t, -

i,tZi ,t ,

(7)

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and Integration Parameter Modelto Test for Predictability Rockingerand Urga: A Time-Varying
i, t

75

2 = 3/+,2 0P+2 ,t-

{et l

>o
?

2i, = e+,tI{e, 3t
i

.>0}
e ,t- I1 {e,L _ 1

e, t

,_o<0)

it-l'

(8)

(13)

and a =(i, -( and

ai,t = iai, r-l "i,,.

i,,tt),

(9)

a() =a

T)

'G)(14)

(10)

The meaning of the variables in Equations (5) to (10) is the same as for Equations(1) to (4). Here, in addition,the errors are also assumed to be independent of each and ri,, zi,t and their other and across time, independentof the ZD,, tr,,t to apply the Kalman-filter methodology,we lags. Furthermore assume that the errors are distributednormally with mean 0 and variances 1 and Qi,,, respectively. to see from (6) how a foreign shock It is straightforward directly affects the first moment of returns. This specification also shows how foreign shocks affect local volatility. In fact, conditional residual volatility for country i can be writ2 if E,_[ED,,e,] = 0. This ten as Et_1[E, ] (a(2)) ot + latter condition means that foreign shocks are supposed to be uncorrelatedwith domestic ones. Following BH, it is possible to measure the part of local variance accounted for by the dominant marketthrough (a,2)2 r ,Dt ?a+t. t/[(2)2 Since Et,_[Ei, tED,t] = a(2)o2t, we also observe that the correlation of country i with the dominantcountryD is given by
Pi,

It is worth noticing that there are advantages in using the Kalman-filter approach with respect to the switchingregression method to test for varying coefficients. First, the Kalman filter does not suffer from some of the drawbacks of switching regressions. For instance, in switching regressions it may become numerically burdensome to find the reason the relation between parametersvaries. To see this, consider a Markovian switching model with just a mean and a variance. To ensure that all possible values for the mean and variance are reached, four states are necessary. This corresponds to a transition matrix containing 12 independent elements. The addition of a single regressor requires eight states to guarantee identification and a transition matrix with 56 independent elements. Such a system is likely to be overidentifiedand its estimation numerically difficult. Second, testing hypotheses within the switching framework is very complicated; for example, see Hansen (1991), who implementeda test for switching, because underthe null of no switching the informationmatrix is singular. Within the Kalman-filtersetup, the test for time variabilityboils down to a test of the constancy of a variance.

1.2 NumericalIssues
To ease the speed of convergence of the algorithms used for the estimation procedures,we also simplify the structure of the model by introducing meaningful restrictions. First, we assume that the variance-covariancematrix, Q,, is diagonal. This means that changes in the parametersoccur independently the one from the other. This assumption does not appear to be restrictive on economic grounds since we do not expect, at daily frequency,any relation between expected returns (captured by the coefficient a(0)), and predictability (a(')), or changing integration(a(2)). On the other hand, we can indeed expect changes in predictabilityand in integration to be correlated.However,since we expect such changes to be of rathersmall magnitude,negligible covariancesare expected. To implement the Kalman filter, we also assume normality of the residuals. We correct the standarderrorsfor possible nonnormality following Bollerslev and Wooldridge(1992), who extendedthe model of Gourieroux,Monfort,and Trognon (1984) to a dynamic model. See also Wooldridge(1994). Finally, to obtain initial values for the general model, we proceed stepwise, startingfrom a reduced model and adding subsequentvariables. Once a solution is found, we check for multiplicity of solutions. We find that there are indeed local maxima for the log-likelihood.

(2) ai,'t [(al)2

(D, t t +i2 t 1/2

This result shows that if foreign volatility increases with respect to local volatility, then volatility increases across markets, a phenomenon put in evidence by Longin and Solnik (1995). Moreover,if dominantmarketshave a stronger impact on local markets,this correlationis higher. Our model is, therefore, able to decompose a country's volatility into an idiosyncraticand a foreign component as in BH. Based on intuitive arguments,we now wish to discuss how the model can be adaptedto emerging markets. The variable xi,, can capture, as did Bekaert and Harvey (1997), macroeconomic variables. For very young market economies such as the transition economies we are dealing with, such variables do not exist or are of such a poor quality that their introductionmay create more problems than it resolves. Other macroeconomic effects such as political events and expectations are not directly measurable. Thus, being unable to condition the parametersdirectly on macroeconomic variables as in BH, we rely on a latent specification for the constant, time-varying autocorrelation, and time-varyingmarketintegration. Our model could also be applied to situations in which high-frequencydata are availableby following Harvey (1989, 2. EMPIRICAL RESULTS sec. 6.3). Following these remarks, Equations (5) to (10) may be The model presentedin the previous section is particularly reformulatedas suitable to test if a transitionstock marketbecomes more efficient over time and more integrated with other established (1) (2) (0) ( ) + a, , ri, ri, t = ai, t ei, t, t ED, t t-I stock markets. Before testing for these hypotheses, we first = (12) provide some descriptionof the data utilized. ei,t Oi,tZi,t

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76

Journalof Business & EconomicStatistics,January2001

240

2.1 DataDescription
For the CEEFM we consider stock indexes for the Czech Republic(CZ), Poland (PO), Hungary(HU), and Russia (RU). Other stock indexes are available such as those of Bulgaria, Slovenia, Romania, Croatia, and Estonia. However, we did not analyze these because they are available for too short a period of time. Most importantly, these countries still have very high barriersto internationalcapital flows, which makes the issue of integration irrelevant. The established stock markets (ESM) considered in this study consist of the American (US), German(GE), and British (UK) markets.All series will be taken at a daily frequency.For furtherdetails on the origin of this data, see Appendix B. Since we take the standpointof an internationalinvestor with a dollarreferential,indexes were convertedinto U.S. dollars, when necessary.This implies that any effect measuredin dollarreturnscan come from movementsof the exchange rate or from a variationof returnsmeasuredin local currency.As in most of the literature,including BH, we do not separatethe various effects. To illustratethe evolution of the CEEFMindexes described previously, we present in Figure 1 a graph of the indexes for the longest possible time span. All indexes have a common period from April 7, 1994, to July 10, 1997. They were rescaled to take the value 100 on April 7, 1994. For comparative purposes,we also presentin Figure 2 the evolution of the U.S., German,and U.K. stock markets.These graphsindicate that 100 U.S.$ invested on April 7, 1994, in a portfolio replicating the indexes would have yielded by July 1997 significantly different amounts of wealth taking the values $46 for the Czech Republic, $77 for Poland, $397 for Russia, $221 for Hungary,$158 for the United Kingdom, $169 for Germany, and $202 for the United States. Such big differencesjustify the modeling of the various index to gain a furtherunderstanding of how they interact. The series for Russia shows a strong peak located in the middle of 1994, which also appearsin other Russian indexes not used in this study.The peak coincides with the creationof a CentralDepository ClearingHouse in July and the creation
520 500 480

200

USA 160 Germany UK

i

120

80

EstablishedStock-Market Indexes. Figure2. Plot of Various

of the Russian FederationCommission on Securities and the CapitalMarket.The end of this spurt was caused by the collapse of the banking system. This peak was also documented by Rockinger and Urga (1997).

2.2 Descriptive Statistics

To ensurethat the statisticalpropertiesmeasuredin the time series for the variousindexes are comparable,we focus on the data over the common time span (April 7, 1994, throughJuly 10, 1997), which correspondsto 867 observations. Following the recent literature(Richardsonand Smith 1993; Bekaert and Harvey 1995, 1997), we obtain heteroscedasticrobust estimates of the mean, variance, skewness, and excess kurtosis within the generalized method of moments (GMM) framework.This frameworkalso provides t tests for significance of the moments.A test for normalitycan be constructed with the Wald principle by imposing zero skewness and no excess kurtosis in the GMM estimation since under normality both statistics should be 0. The associated overidentification statistic W is then distributedas a X2 underthe null. We also report the Jarque-Beratest for normality distributedas
a
2

Inspectionof Table 1 revealsthatthe variousindexes behave in a very complex manner. For the mean of the returns I the range is between -.09 for the Czech index and +.20 Czech I for the Russian index. The annualized volatility, defined 340 Hungory 320 ............ Polond i I times daily volatility, ranges from 9.4% for the as N2 . 300 Russio I 280 I 1 United Kingdom up to 51.4% for Russia. The mean and 260 ,l ,. I 240 i | II volatility for ESM are of a similarmagnitudeand rathersmall. 220 200 A ,I , I Claessens et al. (1995, p. 138) reportedfor the emerging mar140 kets of Asia and SouthAmericafor datarunningbetween 1975 )%j and 1992, coefficients similar to those for our set of emerging ,, 100 markets.However,they find a higher volatility for established markets. This is because in our sample these markets were rathercalm and without crashes. For all series (except for Hungary)we notice a significant negative skewness. This means that for these markets there Market are occasional drops that cannot be captured with a normal Central EasternEuropeanFinancial Figure1. Plot of Various Indexes. for all series we notice excess kurtosis density. Furthermore,
460
440 420 F 400 380

ji

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ParameterModelto Testfor Predictability and Integration Rockingerand Urga: A Time-Varying Table1. DescriptiveStatisticsat DailyFrequency Countries Statistics Sample size Mean Median Annual.volatility Skewness sk* Kurtosis ku* W Jarque-Bera Engle(1) Engle(2) Autocorrelations Rho(1) Rho(2) Rho(3) Rho(4) Rho(5) Rho(6) Rho(7) Rho(8) Rho(9) Rho(10) Rho(15) Rho(20) BL(10) CZ 850 -.0910 .0000 17.21 -.64 -6.16 6.72 11.78 141.68 1,660.10 64.99 72.94 .231 .219 .080 -.007 -.003 -.052 -.012 -.049 .001 .031 -.043 .054 107.73 HU 868 .0838 .0340 22.62 .17 2.11 3.48 15.86 231.45 430.30 28.09 28.02 .119 .012 .006 -.013 -.011 .004 .083 .063 .009 .030 .091 .048 46.14 PO 868 -.0760 .0000 39.19 -.36 -7.04 4.29 50.21 2,539.30 673.14 48.00 89.38 .187 .057 .005 .076 -.078 -.044 -.031 .010 .020 .008 -.050 -.096 61.93 RU 868 .2000 .0000 51.46 -0.21 -4.69 38.70 151.54 22,967.52 57,518.61 .02 60.05 .135 -.020 .064 .077 .182 .097 .065 .076 .104 .139 .036 .062 114.03 US 868 .0766 .0968 11.46 -.53 -3.47 2.92 3.80 18.22 366.23 0.74 3.01 -.047 .032 -.048 -.001 -.079 .028 -.027 .032 .057 -.056 -.035 -.045 32.43 GE 868 .0539 .0681 11.53 -.73 -2.79 2.63 3.65 15.75 281.36 2.10 9.27 -.018 .027 .000 -.012 .026 -.108 -.008 -.005 -.026 -.002 .007 -.083 31.03

77

UK 868 .0573 0.1013 9.40 -.20 -1.51 .99 1.30 3.10 44.08 1.19 5.55 .026 .080 -.063 .001 -.070 -.057 -.048 -.039 .029 -.056 .010 -.031 35.98

NOTE: We report heteroscedastic-robust estimatesof the mean,variance, skewness and excess kurtosis obtainedwithin a GMM framework. Thisframework also providest tests forsignificance of skewness and kurtosis(sk* and ku* respectively). We also reportW, a statisticcorresponding to a test for normality. The distribution of this variable is a X2 underthe nullof normality. The traditional test for normality is distributed as a X2 with2 df. To pre-testfor heteroscedasticity, we reportEngle(L)-that is, the Lagrangemultiplier statisticT R2 corresponding Jarque-Bera to a test of significanceof the parameters as a X2 a, j = 1,..., L, in the regressionr2 = ao + L ajr_ + ui, wherewe choose L to take the values 1 and 2. These statisticsare distributed with1, respectively, 2 df BL(10) respresentsa Box-Ljung test constructedwith10 lags. Whenthe Engletests suggest heteroscedasticity, the Box-Ljung test is adjustedfor type portmanteau Thisstatisticis distributed as a X20.The 95%critical levelfor a X2 (X2,X20)is 3.84 (5.99, 18.3).The critical levelforsignificance of autocorrelations is .067 (.056)forthe 5% heteroscedasticity. (10%)level.

implying fat tails of the returns distribution.Finally, the W and the Jarque-Berastatistics indicate that all series are nonnormally distributed.Possible explanations for nonnormality are that the underlyingreturnsare heteroscedasticand/or that there are jumps in the indexes. We now focus on autocorrelations. Marketswith low autocorrelations are considered to satisfy one criterion for weak informational efficiency. General equilibrium models allow for autocorrelationsin the long run (e.g. Campbell, Lo, and MacKinlay 1997). Because of transactionscosts and because of possible thin trading in stocks (a particularlyimportant issue for emerging financialmarkets),a significantautocorrelation cannot be ruled out. We test for autocorrelationusing a Box-Ljung-type test adjustedfor possible heteroscedasticity following Cumbyand Huizinga (1992). Inspectionof the autocorrelationsreveals for most CEEFM series a strong positive first-orderautocorrelation.For the ESM, on the other hand, we observe a very small autocorrelation. We test for parametricheteroscedasticity with the Engle (1982) test. For all CEEFM, we find series-significant heteroscedasticity up to the second order. There is no sign of ARCH-type heteroscedasticityfor the ESM, the only exception being Germany,which exhibits some second-orderheteroscedasticity.We verifiedthese results with a directGARCH estimation. These observationslead us to stipulatethe following restriction for the ESM described by Equations (1) to (4): ro,, =

aD EDt, where ED,t is a homoscedasticresidual.We will use these residuals as the dominant-country shock that may have an impact on the four CEEFM.

2.3 Estimation of the General Model for Countries Emerging

Having obtaineda specificationfor the dominantcountries' stock-index returnsdynamics, we turn to test the integration of transitioneconomies, the predictabilityof asset returns,and the leverage-liquidity hypothesis by estimatingEquations(11) through(14) for the transitioneconomies. It is worth noting that we experimentedwith selected models allowing for seasonalities in the mean specification and we verified that omission of such features does not substantially change the resultsto be reported.Moreover,introducing, for instance, a day-of-the-week effect in the GARCH equation does not change the general patternsreportedbut highly increases the time requiredto reach convergence. The results are reportedin Table 2. We know (Harvey 1989, statisp. 236) that a formaltest of qj = 0 involves nonstandard tics and, hence, that the associated standarderrorsare meaningless. For this reason we do not reportthem in the article.If the estimatedqj = 0, then clearly the associatedparameter is a constant.It is then possible to formallytest at the conventional level if the correspondingao() = 0 or not. If the estimated qj is nonzero, then the associated j) varies and it is possible to

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78

Journalof Business & EconomicStatistics,January2001

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Parameter Modelto Testfor Predictability and Integration Rockingerand Urga:A Time-Varying

79
1 1 + .9 1T 1 , ,/tr /Pt 1

test if during some period of time the aj) = 0. This can be conveniently achieved in a graph where one reportssmoothed estimates of atj) and 95% confidence intervals. 2.3.1 Testing for Integration. In this section we discuss if the geographicallydominantcountries' shocks have an impact on the CEEFM.We measurethe impact of a dominantcountry through the time-varying parameter a', whose dynamic is given by at2) ) 1+ ,2) where rl2) N(0, qY Czech Republic:For this countrywe notice that q2 equals 0 for the United States and the United Kingdom. Moreover, since for the United States also a(2) is not significantlydifferent from 0, we conclude that there is no integrationbetween the U.S. and the Czech market.Moreoverthe estimate of a 02) for the United Kingdom (.1077) is marginallysignificant.This suggests that shocks in the United Kingdomhave an impacton the Czech marketand, moreover,that the relationbetween the two markets did not change. When we turn to Germany,we find a nonzero q2 of .0099 and, thus, we find that the relation has changed throughtime. Turningto the plot of the evolution of the parametera(2) displayed in Figure 3, we notice that between the beginning of our sample and the end of spring 1995 shocks in Germany became more and more important for the Czech Republic, with the coefficient ac2) increasing to .25. Since then, both countrieshave become less integrated with a coefficient of at2) equal to .1 by the end of June 1997. Hungary: For Hungary we notice that q2 is 0 for both the United States and the United Kingdom. Moreover, even though the point estimates of a2) are positive, they are not statistically significant. This means that shocks in the United States and in the United Kingdom had no impact on the Hungarianmarket. When we turn to Germany,we obtain a positive q2. As Figure 4 shows, the point estimate of ac2) increased to .18 by February 1995, but it decreased subsequently to less than -.2. Moreover, the confidence intervals around the a (2) trajectory get larger toward the end of the sample. This leads us to conclude that Hungary has been influenced very little, over the period under consideration in this study, by any of the potentially dominant countries. Anecdotal evidence confirmedthe fact that during this period
0.40

0.4

0.2-

--

". .

9 1.96

-0.2

-0.4

-0.6
C4

Figure 4. Smoothed Estimates of a2,t Indicatingthe Impact of Market. GermanShocks on the Hungarian

of time the Hungarianmarketwas little influencedby foreign forces. The only countrythat matteredsignificantlyfor a short period was Germany. Poland: The patternfor Poland is somewhat similar to that of the Czech Republic. We observe again that q2 equals 0 for both the United States and the United Kingdom. Once more a(2) is significantlydifferent from 0 for the United Kingdom but not for the United States. We do find that the importance of Germanyhas changed throughtime (see Fig. 5). After an initial period when Germany'sshocks mattereda lot, political events matteredmuch less. Russia: As could be expected given the importanceof the Russian market,the patternfor this country is somewhat different from the previous patterns.We notice that q2 equals 0 for the United Kingdom only. For the United Kingdom the estimate of a(2) has a negative sign but is nonsignificant.Both the United States and Germanyare found to have positive q2In Figure 6 we presentthe graphof a(2) for the United States; the graphfor Germanyis very similar.Initially we notice that this coefficient is strongly negative (-1.19), but it increases
1.8

So-

, +196 lPt OT-1 96 "Ptr

at 1.96 /Ptrr
-, %-1.96 V

/
0.30

1.4

. -

025
0.20

/ /

"

1.0

/ 0 -0.00 05 / / 00

\ -0.2 /

-0

"0-

Figure 3. Smoothed Estimates of a2,, Indicating the Impact of GermanShocks on the Czech Market.

Figure 5. Smoothed Estimates of a2,t Indicatingthe Impact of GermanShocks on the Polish Market.

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80
0.8 ot+i.96
PT

Journalof Business & EconomicStatistics,January2001

predictabilityhas changedthroughtime. We also find that the equation involving the U.S. market leads to no variation in that parameter.We notice that all the estimates of a0 are similar-.2614 for the U.S. regression, .2881 for Germany, and .2548 for the United Kingdom. The graphs obtained for a ') for Germanyand the United Kingdom are virtuallyindisFor this reason we present only the graph for tinguishable. -0.84 Germany (see Fig. 7). We notice that ac1) always oscillates around .26, the value found in the U.S. regression. In a first stage, lasting until November 1994, we found that the market became more predictable. Anecdotal evidence suggests that during this period hundredsof companies of the first wave of were being tradedand that a second wave of mass privatization was under way. Foreignersseemed to be relucprivatizations - 0ooo o 00o o0o oooo-,tant to invest in this marketbecause of its apparentinefficient functioning. As domestic funds bought second-wave compathe marketbecame more illiquid and more autocorrelated nies, Figure6. Smoothed Estimatesof a2,t Indicating the Impactof U.S. Shocks on the RussianMarket. from then until mid-June 1996, but as liquidity subsequently diminished.This is the period when increased,autocorrelation the Ministry of Finance took action against a dozen frauduthroughtime, ending up close to 0. This findingindicatesthat, lent investmentbanks to deal with the showing determination since 1994 when the Russian marketappearedto live a life of as a of consequence which the marits own, it startedto evolve toward a situation of no correla- banking-sectorproblems, ket rose and became again less liquid. This culminatedtoward tion ratherthan negative correlation. the end of 1996 when a Senate election saw the reform-eager 2.3.2 Testing for Predictability. In this section we coalition confirmed. For the Czech market, we address the issue of whetherthe CEEFMunderconsideration government thereforefind two periods of increasingpredictability. which we would interpretas have become less autocorrelated, Hungary and Poland: All the estimates of q, are found to a condition of increasing (weak) marketefficiency. We meabe equal to 0 for the two countries.There is no time variabilsure autocorrelation throughthe possible time-varyingparam(1) (1) (i) ,- N(0, q ). We continue to ity in predictability.When we turn to the point estimate of eter a((1) = at1 I+rt , where q , we notice that for Hungarythe parametersvary between present the results of our global model including the various ao .0265 (for the U.K. regression)and .0348 (for the U.S. regresforeign shocks. For cases in which the foreign shock has not In no case do we find significantcoefficients.For Poland been found to be statistically significant, one could estimate sion). we find that the estimates of a4l) vary between .1639 (for the model withoutit. To save space, we continueto presentthe the German regression) and .2439 (for the U.K. regression). overall resultsreferringto the estimatesobtainedin a restricted Unlike in Hungary,in Poland the parameteris highly signifimodel when necessary. cant. These results suggest that the Hungarianmarketappears Czech Republic: When considering the regressions includto have reacheda ratherhigh level of weak efficiency already ing German and U.K. shocks, we find a q, of .0167 and of 1994 when our sample starts. A possible explana.0140, respectively, and as a consequence we conclude that by April tion is that this market was characterizedby its rather special stature within the former Soviet bloc. When the Stock Exchange was officially founded in 1990, it already had 10 / /Pr years of experience in securities trading. Moreover, thanks 0.5 -196 Pt to an automatedtrading system that was introducedin 1994, transparencyin the orders was assured. For the Polish market the coefficient of predictabilityis constantand ratherhigh. Anecdotal evidence suggests that trades were due mostly to domestic activities. It should be recognized that this market is also rathernew since restrictionsto foreign participation in the marketwere eased only in July 1994. Russia: Inspection of q, indicates that predictabilityhas evolved throughtime. We also notice very similar point esti-0.1 mates of auojfor the variousregressions.Figure 8 displays the of the Germanregrestrajectoryof al) using the parameters sion (the figuresfor the otherparameters are very similar).We notice that at the beginning of the sample days with returns higherthanexpected were followed by days with returnslower Figure 7. Smoothed Estimates of ac1t Representing Time-Varying than expected. This picture had changed by mid-1995 when Predictabilityfor the Czech Market (parameters from the GE we observe a decreasing reverse relation. However, the stanregression). dard errorsare found to be larger so that the null of no pre-0.0 o?) it o 0.6 ,Ot"+1.96 0.4 -0.2

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and Integration Parameter Modelto Testfor Predictability Rockingerand Urga: A Time-Varying

0.30
0.25 --

81

greater volatility subsequent greater liquidity if investors are initially deterredfrom selling in an illiquid market and take advantage to dump their positions 0.15 ' once greaterliquidity has been achieved, a feature we called 0.10 the liquidityhypothesis in the Introduction. Alternatively,it is 0.05 possible that given the short time series no relevantnegative news has hit the market, or it is possible that markets have -0.00 --.--been anticipatingonly negative news. The parametermeasuring the persistence of volatility, 1', -0.10 takes for all countries, except Hungary,values around.7. For , -0.15 Hungarywe find a value of about .28 implying that volatility dies off very quickly. 2.3.4 Evolutionof the LatentFactor We now turnto the discussion of a0?). Again the dynamics of this parameterare This paramgiven by a =(o (a (1+ ),where N(0, qo0). Figure 8. Smoothed Estimates of a ,t Representing Time-Varying eter representsa latent factor and is expected to capture the Predictabilityfor the Russian Market (parameters from the GE evolution through time of the expectation of macroeconomic regression). variables such as interest rates and other fundamentals. Czech Republic:For all regressions,we find that q0 is positive and between .0146 for the U.S. regression and .0190 for dictability cannot be rejected. Our results suggest that, after a the U.K. regression. The values of q0 are thereforevery simperiod of some overreaction,marketsbecame more liquid. ilar. for all regressions we find extremely simFurthermore, 2.3.3 The GARCHStructure for the CEEFM. We would ilar for values like to emphasize that to the best of our knowledge this is aoo). Figure 9 displays the evolution through time of this coefficient for the Germanregression.As could be model incorporates the first article in which the Kalman-filter from the fact that the point estimate of a(0) takes the asymmetricGARCH featuresin the residuals.We will discuss expected the normalityof the residuals, the asymmetryof the GARCH value -.4469 and its variance q0 is very small, we find that for most of the time the latent factor is negative. This obsereffect, and possible correlationsbetween residuals. We test for normalityby using a Wald test, W, as outlined vation indicates that for this marketexpectations were rather in Section 2.2. Inspection of Table 2 and comparison with gloomy. This observationis in line with what we may infer Table 1 reveal that these statistics have strongly decreasedfor from Figure 1, which shows a ratherpoor performanceof the all markets. However, for all countries we continue to reject Czech market. Hungary: Again we find that q0 is positive and that for all normality. This justifies the fact that in Table 2 we report errorsadjustedfor nonnormality the regressionsthe coefficient is very similar,rangingbetween maximumlikelihood standard .0096 and .0098, suggesting that at capturesa time-varying following Bollerslev and Wooldridge(1992). We notice that for the Czech Republic there is no asymme- latent factor. Figure 10 plots the dynamics for the German try in the GARCH process. regression.We notice that, after an initial pessimistic financial For Poland (except for the regression with the United market,from June 1995 on, this marketwas ratheroptimistic. Kingdom)and for all regressionsinvolving Russia, we observe traditional asymmetries: Negative news creates volatility. This finding seems to confirm the leverage hypothesis of 0.4 Black (1972). When a negative shock hits the market, the atr value of equity decreases, leading to a shifted debt-equity 0.2 structure.The increased risk in the companies translatesinto higher subsequentvolatility. For Poland, once we have the United Kingdomin the equation, asymmetries disappear.This indicates that bad news in Poland is related to bad news from the United Kingdom. Possibly, when investorsin the United Kingdomsuffer a drawback, they withdrawfunds from Poland, which in turn leads -0.4 N0 00 " to a fall in the Polish market. For Hungary we find that positive news increases volatility. A similar feature was discovered by Bekaert and Harvey (1997) for 3 out of 10 emerging countries,but it has not been commented on. Possible explanationsfor this finding are the following: It is possible that the marketsunder consideration are generally very illiquid. Once a piece of good news hits the Figure 9. Smoothed Estimates of a, Representing Evolutionof market, foreign capital may be attracted.This could lead to the Latent Factor for the Czech Market (parametersfrom the GE increased liquidity. In typical market-microstructure models, regression).
a1.6

greater liquidity also leads to smaller volatility. In emerging O tff J9 %Ptr can arise to economies,
1 1 1

0.20

--

-0.05
-0.20

-1.96

VPr

-0.6

i0

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82
0.6
a-

Journalof Business & EconomicStatistics,January2001

aI
P++1.96

I
/PU

0.5 0.4

0- -.

T
am-1.96 %/Ptl

mentals. Again, these variationsgo hand in hand with those that can be deduced from Figure 1.

3. CONCLUSION
0.3 0.2

0.1
//
-0.2

Figure 10. Smoothed Estimatesof aot RepresentingEvolutionof the LatentFactor for the Hungarian Market(parametersfrom the GE regression).

Poland: Inspectionof q0 reveals that when we consider the the shocks of Germanyor the United regressionincorporating States, then no time variabilityis found for the latent factors. On the other hand, when we consider as foreign shocks those innovationsdrivenby the U.K. market,then q0 is positive and the latent factor appearsto be time varying.This suggests that Poland has not only a time-varyingintegrationwith Germany but that those foreign shocks are able to act as a substitute for Polish macroeconomic expectations. These observations underscorethe regional importanceof the Germanmarketnot only on the financial sector but on the economy as a whole. Russia: Here q0 has an order of magnitude of .10-.12, which is similarto the Czech case. The estimatesfor the starting value are very similar, ranging between 2.4831 for the U.S. regression and 3.2419 for the U.K. one. Parameterestimates, when allowing for different foreign shocks, are comparable.Figure 11 displays the variationthroughtime of a! ). We observe large fluctuations in this coefficient, indicating great reversalsin the expectationsconcerning Russian funda-1 o\n+1.96VPm
at \ " -/-

This article introducesa model, based on the Kalman-filter latentfacframework,that allows for time-varyingparameters, and a GARCH for structure the tors, residuals,extendgeneral the Bekaert and model. With this extension ing Harvey(1997) it is possible to test if an emergingstock marketbecomes more efficient over time and more integrated with other already established markets. We apply this model to the main Central and Eastern European Financial Markets-namely, the Czech, Polish, Hungarian,and Russian stock markets.First, concerningmarket integration, we find very similar results for the Czech Republic, Hungary, and Poland. For these countries, the United Kingdom always played an importantrole. Germany played an important role until spring 1995 but not after then. Given its geographicaldistance, these marketswere not affected by the U.S. market.For the Russian market,the picture is different. Before 1995, access to the Russian market would have allowed U.S. or Germaninvestorsto hedge against local risks. The negative correlationbetween Russia and the United States and Germanydecreasedafter that. we find that the Hungarianstock Concerningpredictability, market has a rather low level of predictability.One possible reason is high liquidity and the fact that among all the transitioneconomies consideredthe Hungarianmarketalready existed for 10 years before it opened officially in 1994. Poland and the Czech markethave high predictabilitywith peaks for the Czech market in November 1994 and April 1997. The Polish marketremainedconstantly high. The Russian market has a very differentpattern.It evolved from a marketwith negative autocorrelation (possibly due to overreactionof market with no predictabilityby June 1997. to a market participants) within the general model developed we find Furthermore, that for all countries investigated there exist significant GARCH effects compatible with Black's (1972) leverage hypothesis. The exception is Hungary,where it is found that good news generates more volatility than bad news. We provide several explanationsfor this phenomenon.

"1

ACKNOWLEDGMENTS

"
\/I

o
I ' I

r
\ I

\ -2 .

We acknowledge valuable comments from R. Chirinko, B. Dumas, S. Hall, and E. Jondeau.We also thank the editor and an associate editor for helpful suggestions.We thankJordi Riera for research assistance. The data used in this study were extractedfrom Datastream,Reuters,Bloomberg, and the Financialsupportfrom PHARE-ACEProjectN. T97Intemrnet. 8118-R is gratefullyacknowledged.The first authoracknowledges financialhelp from the HEC Foundation. OF THE KALMAN APPENDIXA: IMPLEMENTATION AND THE SMOOTHERWITHGARCH FILTER EFFECTS IN THE RESIDUALS In this appendixwe describe how to implementthe Kalman filter and smoother with GARCH effects in the residuals.

-3

of Figure 11. Smoothed Estimatesofao,t RepresentingEvolution the LatentFactor for the Russian Market(parametersfrom the U.S.

regression).

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and Integration ParameterModelto Testfor Predictability Rockingerand Urga: A Time-Varying

83

Following the notations of Harvey (1989, pp. 100-105), we assume a general state-spacemodel written as Yt= zat + E,, E[E,] = 0, and at, = T,a,_, + R,r,, E[r,] = 0, V[r,] = Q,. (A.2) V[E,] = Ht (A.1)

Since these equations do not depend on v,, once parameters have been estimated, it is possible to use the traditional smoothing equationsdirectly.

OF THE B: INFORMATION CONTENT APPENDIX USED INTHISSTUDY STOCKINDEXES

In this appendix we provide information on the indexes used. It should be noticed that all CEEFMcountrieshave continuous auctions. Both the Russian and the Czech marketsdo not have any price controls, while the Polish and the Hungarian marketslimit price changes from session to session. 1. CzechRepublic-PX50:Availablebetween April 7, 1994, and July 10, 1997, the PX50 (with PXL and PX-Glob) is the of a family of indexes that includes 22 leading representative indexes. The PX50 is the most attractiveCzech stock index (traded on the Prague Stock Exchange) in terms of turnover and market capitalization. The composition of the index is revised quarterlyas of the first session in January, April, July, and October. 2. Hungary-BUX:Available between December 12, 1991, and July 10, 1997, the Budapest Stock Index (BUX) replaced the unofficial Budapest Stock Exchange Index that was used during the initial phases of the country's economic transition. Currently,the BUX contains 17 stocks. To qualify for the index, a stock has to comply with several requirements, including a certain minimum face value, a defined minimum price, a minimum number of transactions,and a cumulated minimumturnoverof 10% of the registeredcapital duringthe six months precedingthe revisions of the index. 3. Poland-WIG: Availablebetween December 6, 1991, and July 10, 1997, the Warsaw Stock Exchange index was the first index to be introducedafter the reopeningof the Warsaw Stock Exchange. The index is calculated after each trading session, and since January 1997 it has contained 66 stocks, compared with 39 stocks in April 1995. It is calculated as a weighted index for the main market,once per trading day, after each trading session. The weight of an individual stock to its market capitalization is limited to 10% of the index a single sector may not accountfor more sample. Furthermore, than 30% of the index. The index is regularlyrevised every three months, mainly to account for the introductionof new stocks. 4. Russia-ROS:Availablebetween December 1, 1993, and July 10, 1997, this index is provided by the CS First Boston investment bank. The index is capitalization weighted and includes the 30 most liquid stocks. This index is ruble denominated and available on a daily basis since August 1, 1994. 5. USA-S&P 500: The S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation.It is a market-valueweighted index. For all ESM, we use data covering the period for which we also have data for the CEEFM. 6. Germany-FAZ: The most quoted index for Germany is the FAZ (Frankfurter Allgemeine Zeitung) index. It is a index weighted (100 stocks), the composition of which has not changed for almost 10 years.

Equations(A.1) and (A.2) are referredto as the measurement and transitionequations,respectively.The disturbances,E, and rq,,which can be vectors, are assumed to be distributednormally and to be uncorrelatedwith each other and across all time periods.y, is an observation.z, correspondto explanatory variables. The a, are latent variables that we try to estimate. Time runs from t = 1 to T. Let Is be the set of all informationavailableat time s. Then, by defining a1ls= E[a,lIs],Ptls= E[(a, - a/is)(a, - atls)'lls], the traditionalKalman-filter equationsthat allow estimationof are equations (A. 1)-(A.2)
artlt= - tat_l,

Plt-,_ = T,P,_T/+ RtQtRt,

=
Ylt-1

ztatlt-1,

vt = Yt- Ytit-l' F, = ztP,tltz Ht,

+ Ptlt_IZF,-'v,, a, = atlt_1 and = P, (I - Ptlt_,z'Ft' z,)P,I,_I. We notice, as did Emerson,Hall, and Zalewska-Mitura (1996), that vt representsan estimate of the residual Et. Clearly,given the way the filter is conceived, at time t, v, v2, ... , vt are known. It is therefore possible to incorporateany GARCH effect by adjusting Ht. For instance, a GARCH(1,1), with (1994) can be impleasymmetries modeled as by Zakodian mented with H, = bo+ bvt_1,_ o}+b -vt_lR, + bH,_,.Ht.

OtherGARCH models (see Crouhyand Rockinger 1997), can be similarly implemented. Various initializations are possible for the GARCH component. One possibility is to set H0 = [b_ + (b +? b-) 1/2ir]/(1 -b,). The log-likelihood for observationt for the Kalman filter is given by I, = 1
I--2

1 1 ln(2ir)- 2 ln(F,)- -vFt'vt. 2t

Errorsthat are due to a poor initializationcan be mitigatedby droppingthe first few likelihood observations. The conventionalsmoothing equations are given by
Pt* = PtT+,' P+'l,It = aLtT ar + Pt(a+?1lT - at+Ilr)

= Pt + Pt (Pt+,r - Pt+IT)P?*. PtIT

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84

Journalof Business & EconomicStatistics,January2001

Asset Pricing Under Mild Errunza,V. R., and Losq, E. (1985), "International Segmentation:Theory and Test,"Journal of Finance, 40, 105-124. Ferson, W. E., and Harvey, C. R. (1993), "The Risk and Predictability of InternationalEquity Returns," Review of Financial Studies, 6, 527-566. (1994), "Sources of Risk and Expected Returns in Global Equity Journal of Banking and Finance, 18, 775-803. [Received October 1998. Revised April 2000.] Markets," Glosten, L., Jagannathan,R., and Runkle, D. (1993), "On the Relation Between the Expected Value and the Volatility of the Nominal Excess Returnon Stocks,"Journal of Finance, 48, 1779-1801. REFERENCES Gourieroux, C., Monfort, A., and Trognon, A. (1984), "Pseudo-Maximum Likelihood Methods:Theory,"Econometrica,52, 681-700. Bekaert,G. (1995), "MarketIntegrationand InvestmentBarriersin Emerging Hansen, B. (1991), "InferenceWhen a Nuisance ParameterIs Not Identified Under the Null Hypothesis,"mimeo, Rochester University, Dept. of Equity Markets,"The WorldBank Economic Review, 9, 75-107. WorldMarketIntegraBekaert,G., and Harvey,C. L. (1995), "Time-Varying Economics. tion,"Journal of Finance, 50, 403-444. Harvey, A. C. (1989), "Forecasting,StructuralTime Series Models and the Kalman Filter,"Cambridge,U.K.: CambridgeUniversity Press. (1997), "EmergingEquity Market Volatility,"Journal of Financial Economics, 43, 29-77. Harvey, C. R. (1991), "The World Price of Covariance Risk," Journal of Black, F. (1972), "CapitalMarket EquilibriumWith Restricted Borrowing," Finance, 46, 111-157. Journal of Business, 45, 444-55. (1995), "PredictableRisk and Returns in Emerging Markets,"The Likelihood Bollerslev, T., and Wooldridge,J. M. (1992), "Quasi-Maximum Review of Financial Studies, 8, 773-816. Estimationand Inference in Dynamic Models With Time-VaryingCovari- Lintner,J. (1965), "The Valuationof Risky Assets and the Selection of Risky ances,"EconometricReview, 11, 143-172. Investmentsin Stock Portfoliosand CapitalBudgets,"Reviewof Economics and Statistics, 47, 13-37. Campbell, J. Y., and Hentschel, L. (1992), "No News Is Good News: An Asymmetric Model of Changing Volatility in Stock Returns,"Journal of Longin, F., and Solnik, B. (1995), "Is the Correlation in International Financial Economics, 31, 281-318. EquityReturnsConstant:1960-1990?" Journal of InternationalMoneyand Campbell,J. Y., Lo, A. W., and MacKinlay,A. C. (1997), The Econometrics Finance, 14, 3-26. of Financial Markets,Princeton,NJ: PrincetonUniversity Press. Richardson,M., and Smith, T. (1993), "A Test for MultivariateNormalityin Behaviourin EmergClaessens, S., Dasgupta,S., and Glen, J. (1995), "Return Stock Returns," Journal of Business, 66, 295-321. The WorldBank Economic Review, 9, 131-151. ing Stock Markets," Rockinger, M., and Urga, G. (1997), "InformationContent of Russian Stock Indices,"DP 24-97, London Business School, Centre for Economic Crouhy, M., and Rockinger, M. (1997), "VolatilityClustering, Asymmetry, and Hysteresis in Stock Returns:International Evidence,"Financial EngiForecasting. neering and the Japanese Markets, 1-35. Sharpe, W. (1964), "CapitalAsset Prices: A Theory of MarketEquilibrium Under Conditionsof Risk,"Journal of Finance, 19, 425-442. Cumby, R. E., and Huizinga, J. (1992), "Testingthe AutocorrelationStrucVariables Solnik, B. (1983), "InternationalArbitrage Pricing Theory," Journal of ture of Disturbancesin OrdinaryLeast Squaresand Instrumental Regressions,"Econometrica,60, 185-95. Finance, 36, 923-934. A. (1996), "EvolvingMarket Taylor,S. (1986), Modeling Financial TimeSeries, New York:Wiley. Emerson,R., Hall, S. G., and Zalewska-Mitura, Efficiency Withan Applicationto Some BulgarianShares,"mimeo, London Wooldridge, J. M. (1994), "Estimationand Inference for Dependent ProBusiness School, Centrefor Economic Forecasting. cesses," in Handbookof Econometrics(Vol. IV), eds. R. F. Engle and D. L. WithEstiConditionalHeteroskedasticity Engle, R. F. (1982), "Autoregressive McFadden,Amsterdam:Elsevier Science, pp. 2639-2738. mates of the Variance of United Kingdom Inflation,"Econometrica, 50, Zakoian, J. M. (1994), "Threshold Heteroskedastic Models," Journal of 987-1007. Economic Dynamics and Control, 18, 931-955.

7. UK-FTSE100: The FTSE Actuaries Share Index is a weighted index of 100 stocks in which the weights are the marketcapitalizationof each company.

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