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Individuals, companies, and the public decide upon the solution of problems in every step of life. One of these problems is the investment decision. On the assumption that there is no borrowing option to finance an investment, the main source of financing is equity capital. Equity capital and financing have two components, the internal source and the external source. The internal source is undistributed profit, and the external source is provided by the issuance of new shares. The price of an equity share is based on knowledge of market conditions. Every piece of information attained in the market and the background of this information is an actual element of risk, and these elements of risk determine the level of volatility in equity shares. Certain elements of risk are of national origin and certain of them are of international origin. For this reason, it is of crucial importance that developments in the stock exchange markets are closely monitored.
Calvi (2010) defines financial integration as the process of closer integration of a country's financial markets with markets in other countries or regions. Economic theory and empirical evidence suggest that financial integration and the development of financial markets will remove barriers before exchange, allocate capital more efficiently, and thus contribute to economic growth. On the other hand, providing more extensive financial attachments between countries or regions may increase the risk of cross-border financial contagion. Thus, financial instability in one country can spread to neighboring countries more rapidly.
Jochum et al. (1999) examined the relationship and interaction between the instability of 1997 and 1998 in world financial markets. They ascertained that in the aftermath of the emergence of the crisis in Southeast Asia, financial market instability rapidly spread to the emerging markets of Eastern Europe and South America. Jochum et al. (1999) revealed that market indices in Eastern Europe followed a common course in the pre-crisis period, and country-specific events did not create a significant spillover between the markets. The results indicated a strong cointegration relationship between markets.
Aggarwal & Rivoli (1989) argued that the conventional view is indeed independence between stock returns in the United States and other countries of the highest magnitude. However, as a general rule, the conducted research studies revealed that other markets tend to be strongly influenced by the conduct of the US market. The results indicate the significant trend to follow the US markets on a daily basis between stock returns in the United States and stock returns in the four Asian stock markets.
In the study by Gerrits & Yuce (1999), they state that due to trade increments and enhanced cooperation between national governments, national economies have become more international, leading to the free flow of goods and services and the removal of barriers to financial, physical, and human capital. In their study, they examined the interdependence between stock prices in Germany, England, the Netherlands, and the USA. The results demonstrated that the USA has a significant impact on the European markets. Moreover, the three European markets influence each other in the short and long term. Therefore, diversification between national equity markets will not greatly reduce portfolio risk without compromising expected return.
Fernández-Serrano & Sosvilla-Rivero (2001) examined the linkages between stock markets in Asia using recently developed cointegration techniques that allow for structural changes in the long-run relationship. The results showed that there is no long-run relationship between Asian stock markets when traditional cointegration tests are applied. On the other hand, there is a strong cointegration relationship in Asian stock markets where there is a prospect of structural break.
In another study, Fernández-Serrano & Sosvilla-Rivero (2003) examined the long-term relationship between the US and Latin American stock markets using conventional cointegration tests and recently developed cointegration techniques. The results demonstrated that the acquisitions from international diversification are limited for long-term investors.