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London Calling: Nonlinear Mean Reversion across National Stock Markets

Hyeongwoo Kim () and Jintae Kim

No auwp2018-01, Auburn Economics Working Paper Series from Department of Economics, Auburn University

Abstract: This paper revisits empirical evidence of mean reversion of relative stock prices in international stock markets. We implement a strand of univariate and panel unit root tests for linear and nonlinear models of 18 national stock indices from 1969 to 2016. Our major findings are as follows. First, we find strong evidence of nonlinear mean reversion of the relative stock price with the UK index as the reference, calling attention to the stock index in the UK, but not with the US index. Our results imply an important role of the local common factor in the European stock markets. Second, panel tests yield no evidence of linear and nonlinear stationarity when the cross-section dependence is considered, which provides conflicting results from those of the univariate tests. Last, we show how to understand these results via dynamic factor analysis. When the stationary common factor dominates nonstationary idiosyncratic components in small samples, panel tests that filter out the stationary common factor may yield evidence against the stationarity null hypothesis in finite samples. We corroborate this conjecture via extensive Monte Carlo simulations.

Keywords: Unit Root Test; ESTAR Unit Root Test; Nonlinear Panel unit root test; PANIC (search for similar items in EconPapers)
JEL-codes: C22 G10 G15 (search for similar items in EconPapers)
Date: 2018-01
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Related works:
Journal Article: London calling: Nonlinear mean reversion across national stock markets (2018) Downloads
Working Paper: London Calling: Nonlinear Mean Reversion across National Stock Markets (2017) Downloads
Working Paper: London Calling: Nonlinear Mean Reversion across National Stock Markets (2014) Downloads
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