The Evolution of Interdependence in World Equity Markets - Evidence from Minimum Spanning Trees

TL;DR

This paper uses minimum spanning trees to analyze how global equity markets have become more interconnected from 1997 to 2006, indicating increased market integration and reduced diversification benefits.

Contribution

It introduces a dynamic analysis of market interdependence using evolving asset trees and measures their structural changes over time.

Findings

Markets became more interconnected over time.

The asset tree showed increased compactness.

Potential reduction in diversification benefits.

Abstract

The minimum spanning tree is used to study the process of market integration for a large group of national stock market indices. We show how the asset tree evolves over time and describe the dynamics of its normalized length, mean occupation layer, and single- and multiple-step linkage survival rates. Over the period studied, 1997-2006, the tree shows a tendency to become more compact. This implies that global equity markets are increasingly interrelated. The consequence for global investors is a potential reduction of the benefits of international portfolio diversification.