Applied Economics Letters

ISSN: 1350-4851 (Print) 1466-4291 (Online) Journal homepage: http://www.tandfonline.com/loi/rael20

Stock market integration in Mexico and Argentina:

are short- and long-term considerations different?
Fredj Jawadi , Mohamed El Hdi Arouri & Duc Khuong Nguyen
To cite this article: Fredj Jawadi , Mohamed El Hdi Arouri & Duc Khuong Nguyen (2010)
Stock market integration in Mexico and Argentina: are short- and long-term considerations
different?, Applied Economics Letters, 17:15, 1503-1507, DOI: 10.1080/13504850903035899
To link to this article: http://dx.doi.org/10.1080/13504850903035899

Published online: 10 Nov 2009.

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Applied Economics Letters, 2010, 17, 15031507

Stock market integration in Mexico

and Argentina: are short- and longterm considerations different?
Fredj Jawadia,b,*, Mohamed El Hedi Arouric
and Duc Khuong Nguyend

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Groupe Sup de Co Amiens, Amiens School of Management, 18, place Saint

Michel, Amiens 80000, France
b
EconomiX, Universite of Paris Ouest Nanterre La Defense, Bat G, Bureau
610 A, 200, Avenue de la Republique, Nanterre 92001, France
c
Laboratoire dEconomie dOrleans, University of Orleans and EDHEC,
Orleans, France
d
Department of Finance and Management, ISC Paris School of Management,
Paris, France

This article aims to study the issue of short- and long-term stock market
integration in two of Latin Americas biggest emerging economies Mexico
and Argentina with the US stock market using multivariate cointegration
tools. Our study covers a period of two decades and shows strong evidence
of Argentina and Mexicos short-term financial dependence on the US
market. However, our results show no long-term linkages between the
markets studied, indicating that Mexican and Argentinean stock markets
are governed more by their fundamentals in the long term.
I. Introduction
The financial linkages among world capital markets
raise several questions for global investors and policymakers. With regard to their concerns, policymakers
seek to understand the nature and the issues involved
in inter-market comovements to manage the harmful
effects of contagion and negative shock transmission
in a globalized finance context. Portfolio managers
need to know the degree of market integration to
rebalance their portfolios. Indeed, they will only add
more stocks to their portfolios to develop international
diversification benefits when a low and moderate correlation is observed between additional and previously
selected stocks. Although the negative correlation is
expected, it is hard to find such kinds of securities
nowadays without investing in emerging and newly
liberalized developing markets. In this scheme of
things, measuring the degree of market integration is

still a hot issue and calls for further research given the
divergence of empirical results that has emerged from
previous studies.
The integration of stock markets worldwide has
been widely examined by a considerable number of
studies in finance literature, using various methods
and econometric techniques. In fact, earlier studies
investigated the issue of market integration from a
comovement viewpoint by measuring the correlation
coefficient among national stock markets (Grubel,
1968), while recent studies often test the integration
hypothesis (full integration, partial integration and
segmentation) based on an asset pricing model
(Errunza and Losq, 1985; Bekaert and Harvey, 1995;
Gerard et al., 2003) or on newly developed cointegration approaches (Richards, 1995).
In this article, we shift our attention to the issue of
dynamic market integration in two of Latin Americas
biggest emerging markets: Mexico and Argentina. In

*Corresponding author. E-mail: fredj.jawadi@supco-amiens.fr

Applied Economics Letters ISSN 13504851 print/ISSN 14664291 online  2010 Taylor & Francis
http://www.informaworld.com
DOI: 10.1080/13504850903035899

1503

F. Jawadi et al.

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1504
particular, we seek to analyse their financial linkages
with the American stock market. This study is
designed to enable global investors to appreciate the
present degree of interdependence between sample
markets and consequently to make portfolio
adjustments.
Our study is motivated by three main reasons.
Firstly, Mexico and Argentina are the largest countries within the Latin American region and the universe of emerging countries. With the embankment of
market-oriented policies and financial reforms, they
are becoming a desirable destination for international
capital flows, thanks to their strong potential for
expected returns and low correlation with developed
markets. For instance, the total of net portfolio flows
to Latin America almost tripled in 2007, rising from
US $3.2 billion in 2006 to US $20.4 billion in 2007,
according to the Institute of International Finance.
Secondly, only a few studies have been devoted to
investigating market integration in Latin America
(Chen et al., 2002; Johnson and Soenen, 2003).
Moreover, apart from Johnson and Soenen (2003),
none of the studies examined the linkages between
these markets and the USA directly even though we
observe a high degree of interdependence during
financial turmoil. Finally, the existence of a high risk
of economic downturn and the vulnerability of
emerging Latin American economies to external
shocks in the context of the current global financial
crisis naturally requires a reassessment of their independence from the USA where the crisis originated.
In Section II of this article, we present the method
used to assess the degree of market integration
between Mexican, Argentinean and US stock
markets. Unlike other studies, our focus is on both
short- and long-term relationships. Empirical results
are also reported and discussed in this section. Finally,
Section III provides some concluding remarks.

Data and preliminary results

Our data consists of monthly stock market indices
from two emerging Latin American countries
(Argentina and Mexico) and the US stock market
index over the period from December 1987 to
January 2008. These indices were obtained from
Morgan Stanley Capital International and are
expressed in US dollars to provide homogenous data
and avoid currency risk. To develop a global view of
the stock price dynamics, we plot the three market
indices together in Fig. 1 (base 100 = 1988).
We suggest that stock prices are not a priori stationary. Moreover, price levels seem to have been higher in
the last decade and there is significant evidence of
comovements between the two Latin American stock
prices shown, even though this is not supported after
2000, when the Argentinean index appears to be in
decline and more volatile and impulsive than the other
indices. This may imply the rejection of the integration
hypothesis in the long term, but from the graph,
further evidence of common short-term statistical
properties between these two Latin American stock
markets because of the effects of synchronization,
liberalization and deregulation of the Mexican and
Argentinean financial systems and the dependence of
their economies and infrastructures on the US
economy is particularly noticeable. Accordingly,
the dynamics of the Argentinean and Mexican stock
price adjustments can probably be studied in the short
and long term using cointegration tools.
We check the integration order of stock prices using
two unit root tests, namely the Augmented
DickeyFuller (ADF) and the PhilipsPerron tests.
Our findings suggest that stock indices are not stationary in the level but are stationary in the first difference,
indicating that Argentinean, Mexican and American
stock prices are integrated in the first order,
noted I(1).1 This is the required condition for the
9

II. Method and Empirical Results

This study employed the cointegration techniques to
investigate the dynamic linkages between sample
markets. We present the statistical properties of the
data used. We then apply the cointegration tests to our
integrated price series to test the market integration
hypothesis. Finally, a Vector Autoregressive (VAR)
model is estimated to highlight the nature and intensity of the financial linkages across the markets
studied.

8
7
6
5
4

88

90

94
LUSA

Fig. 1.
1

92

96

98
LARG

00

02

04

06

LMEX

Stock price representations in logarithm

Results of unit root tests are not presented in detail but are available upon request addressed to the corresponding author.

Stock market integration in Mexico and Argentina

Table 1. Correlation matrix
RARG
RARG
RMEX
RUSA

1.00

1505
Table 2. Linear cointegration test

RMEX
0.43
1.00

RUSA
0.27
0.50
1.00

Price series

Constant

LUSA

R2

Mexico

-0.95*
(-2.45)
0.72
(1.69)

1.24*
(20.95)
0.94
(14.5)

0.65

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Argentina

application of the cointegration technique as we subsequently show.

Table 1 reports the correlation coefficients among
sample markets. We typically observe that they range
from 0.27 (between Argentina and the USA) to 0.50
(between Mexico and the USA). The Argentinean and
Mexican stock markets seem to be linked with regard
to their correlation coefficient of 0.43. Given these
bilateral interdependences, it would appear that each
of our sample markets potentially exhibits some
degree of market integration with the others.
However, these statistics only yield a static analysis
of market integration in the short term. In what
follows, we check the integration hypothesis over the
long term from the cointegration framework, whose
main advantage is the ability to detect both short- and
long-term financial linkages between the markets
under consideration. The model also allows us to
describe the evolution of market integration over
time.
Cointegration tests
Cointegration theory was introduced by Granger
(1981) and further developed by, among others,
Engle and Granger (1987) and Johansen (1988). It
stipulates that variables may undergo some shortterm disruptions, but with some similar properties,
they can establish stable relations between one
another and converge towards a balanced relationship in the long term. Formally, let Xt and Yt be
two variables that are I(1). If it is possible to find a
stationary linear combination zt between these two
variables, then Xt and Yt are said to be cointegrated
and the cointegration relationship is given as follows:
zt Xt  a0  a1 Yt

where zt designates the error term of the cointegration relationship.

In practice, we first estimate the long-term relationship by regressing the Mexican and Argentinean,
stock prices on the US stock market index, represented by Xt and Yt in Equation 1, respectively. We
2

0.46

ADF
(p, model)
-1.61
(1, a)
-2.35
(0, a)

Notes: The values in parentheses are the t-statistics. a denotes a model without constant and linear trend. The order
p is the number of lags retained while applying the cointegration test.
*Denotes test statistic significance at 5% level.

then test the linear cointegration hypothesis by applying the ADF tests to zt. Summarized findings are
reported in Table 2.
According to this table, and comparing the ADF
statistics with the critical values of Engle and Yoo
(1987), we reject the hypothesis of linear cointegration for both emerging market indices and instead
favour the assessment that stock markets in
Argentina and Mexico are not integrated with
those of the USA. To ensure the robustness of the
findings and provide an in-depth analysis of the
issue, we decided to perform the Johansen trace
test that enabled us to simultaneously test for the
cointegration hypothesis and the number of cointegrated relationships between markets. Table 3 reports
the main results obtained.
We also reject the hypothesis of linear cointegration according to Johansen tests. Overall, and
according to cointegration tests, Argentinean and
Mexican stock markets are not cointegrated with
the US market and therefore appear to be
segmented, which is contrary to common assessments. Indeed, in previous studies, several stylized
economic cooperation facts, such as NAFTA,
especially for Mexico suggest a high degree of
linkages and dependence of the Argentinean and
Mexican markets on the US financial system and
economy.2

Table 3. Johansen trace test

Hypothesized
no. of CE(s)

Critical
value
Trace
Eigenvalue statistics (5%)

p-Value

None
At most 1
At most 2

0.067
0.030
0.012

0.122
0.288
0.100

26.223
9.903
2.698

29.797
15.495
3.841

The US Foreign Direct Investments in Argentina consist of 44% whereas those in Mexico are about 54%.

F. Jawadi et al.

1506

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Granger causality tests

Table 5. VAR estimation

Given the invalidity of the market integration

hypothesis, some may wonder what the effects of
one markets shocks on the other markets in the
sample would be. To answer this question, we proceeded as follows. We first performed the Granger
causality test to examine whether stock returns in
Argentina and Mexico are caused by return innovations in the US market. We then calculated a VAR to
investigate the dynamic adjustments of returns in two
emerging markets in the short term within a twomarket VAR system. Note that we only introduced
the US stock market index as an explanatory
variable.
As a brief reminder of Grangers causality test, let X
and Y be two variables. According to Granger (1969),
X causes Y if the forecasting of Y on the basis of the
past tendencies of X and Y supplants that of Y, which
is based uniquely on the past tendencies of Y. Thus,
the Granger causality test tests the null hypothesis of
noncausality against its alternative of causality and is
based on a likelihood ratio test. In practice, we apply
this test to investigate the causality hypothesis
between the two Latin American and the US stock
markets. According to our findings, reported in Table
4, we reject the null hypothesis of absence of causality
for both Argentina and Mexico at 10 and 5% levels,
respectively, suggesting that these markets depend significantly, at least in the short term, on the US market.
Regarding the VAR model, we should firstly recall
that in its traditional representation, it enables us to
examine both the leadlag effects and the causality
effects within the three-market system, whereas its
moving average representation with orthogonalized
residuals enables the impulse response of a specific
market to shocks caused by another market in the
system to be computed.
In the next step, we estimate the stock return adjustment dynamics using the VAR methodology. The
main advantage of this modelling is to simultaneously
reproduce the dynamics of a vector of variables
(Mexico, Argentina and the USA in our case),
enabling us to apprehend the behaviour of several
variables and study their response following a shock

Table 4. Granger causality test

Series

p-Value

Mexico
Argentina

0.03
0.09

RMEX (1)
RMEX (2)
RARG (1)
RARG (2)
C
RUSA
Adjusted R2
Log likelihood
Akaike AIC
Log likelihood
Akaike information
criterion
Schwarz criterion

RMEX

RARG

0.067528
(1.08788)
0.046230
(0.75014)
0.014912
(0.38225)
-0.011005
(-0.28122)
0.006528
(1.20539)
1.179299
(8.91317)
0.243606
266.3247
-2.196833
413.6875
-3.389768

0.047957
(0.43525)
0.220266
(2.01350)
0.021449
(0.30974)
-0.124929
(-1.79844)
0.005270
(0.54822)
1.102549
(4.69453)
0.080263
130.3258
-1.049162

-3.214170

Note: RMEX, RARG and RUSA are Mexican, Argentinean

and US stock returns, respectively.

that may affect any one of them. Unrestricted VAR

model is estimated by the LS method, whereas a
restricted VAR model is estimated by the maximum
likelihood method (Table 5).
In practice, the lag number is determined using the
information criteria but also a likelihood ratio test
testing a VAR(p + 1) against VAR(p). For our application, we retain p = 2.3 Otherwise, as we have
rejected the cointegration hypothesis between the US
and the two Latin American markets, we can estimate
a VAR model in difference. Our estimation of a
VAR(2) results show that the Mexican return does
not depend on the Argentinean index, whereas its
lagged value significantly affects the dynamics of the
Argentinean market at a level of 5%, confirming our
suggestions regarding the first graph. The
Argentinean market tends to depend on its lagged
returns of two periods at the level of 10%. More
interestingly, the current American return significantly affects both Latin American returns, although
the effect is more significant for Mexico. This also
confirms our analysis above as well as the Granger
causality test and suggests that each shock affecting
the New York stock market is transmitted to the other
emerging markets in the short term.
Finally, to explore the dependence of these markets, particularly Mexico, on the US financial system in greater depth, we estimate the impulsion
response function and try to explain the

The details of the determination of lag number are not reported here but are available upon request.

Stock market integration in Mexico and Argentina

1507
III. Conclusion

0.04
0.03
0.02
0.01
0.00
0.01
0.02

10

Response of RMEX to RUSA

This article studied the issue of stock market integration in two major Latin American emerging economies, Mexico and Argentina, with the US stock
market in the short and long term. Over a period of
two decades, we identify strong evidence of Argentina
and Mexicos short-term financial dependence on the
US markets. However, there is no evidence of longterm linkages between the markets studied.

0.05
0.04

References

0.03
0.02

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0.01
0.00
0.01
0.02
1

Fig. 2.

10

Impulsion response functions

consequences of a shock affecting the US return on

those of Mexico and Argentina. In practice, we
orthogonalize the shock using Cholesky decomposition,4 define the shock as an SD and study the effect
of this shock over a 10-month period. For
Argentina, the effect of a US shock is immediate,
and its consequences subside after 5 months. For
Mexico, the effect of the shock is more traditional
as it re-collides while amortizing and disappears
after 3 months (Fig. 2).
Overall, these findings suggest some evidence of
short-term linkages between the US market and
the Latin American stock markets and highlight the
dependence of their financial systems on the American
one. They can also help explain the effects of the
present financial crisis and the transmission of the
subprime crisis to other markets.

See Hamilton (1994) for more details.

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