We explore the co-movements between emerging markets by employing dynamic conditional correlation approach. We additionally explore the factors that might drive the conditional correlations between emerging markets. We show that trade with the high income countries is a more important driver of the co-movements between emerging markets relative to trade with other emerging markets either within or outside the geographic region of the given country. We further document that the overall health of an economy, investment and market depth explain the correlation between emerging markets. Evidence is also provided that although, the recent emerging markets and global financial crises raised the correlation between emerging markets, not all country pair correlations increased around the period of the crisis. The findings show that economic engagement as opposed to geographic proximity is more relevant in describing within emerging markets integration. The findings suggest that diversification gains could be achieved by strategically investing across some emerging markets even in crisis periods.

Introduction

We examine the relationship between cross-country economic activity and the integration among emerging markets. International financial market linkages have relevance for cross-market diversification benefits, macro-economic policies, the price discovery process and the vulnerability of global financial markets to crisis originating from other countries (see e.g. Stulz, 1999; Bekaert et al., 2002; Büttner and Hayo, 2011). Bekaert et al. (2002), Lombardo and Pagano (2002), and De Jong and de Roon (2005) for instance show that increased interdependence amongst financial markets facilitates cross-border investment, reduces capital cost and broadens the opportunities for investment. International capital flows minimise capital constraint problems thereby promoting more productive investments (Acemoglu and Zilibotti, 1997), additionally, capital flows allow international risk sharing which may facilitate risk taking and creative investment in the domestic economy (Saint-Paul, 1992; Obstfeld, 1994). Financial integration permits a more efficient capital allocation across countries – this has a growth enhancing effect. Financial market depth and liquidity, institutional quality and economic activity have consequences for financial markets integration (see e.g. Campa and Fernandes, 2006; Bekaert et al., 2011; Boamah et al., 2017a,b). Deléchat et al. (2010) argue that capital market development leads to increased capital inflows which may consequently lead to a surge in financial market integration. Emerging markets are uniquely characterised by smaller market depth, illiquidity, limited trade among themselves and weak institutional environment. Hearn and Piesse (2013); Hearn (2014) and Boamah (2015) for instance observe that emerging markets are largely illiquid.