Do Political and Economic Uncertainties Separate Stock Markets?

This study investigates the dynamic pattern of the interdependence among G7 stock markets, namely the US, the UK, France, Germany, Italy Canada and Japan over the 1988-2021 period. The state-space formulation of the time-varying cointegrating coefficient allows us to examine the potential drivers of disruption in the long-run co-movement of markets. We relate the state-space variable to world economic uncertainty, political crises and a number of stock market determinants; then, we estimate bivariate cointegration relations between the US and each of the other G7 members using a Kalman filter. Our results reveal that variations in a number of financial risk factors, including economic policy uncertainty (EPU) and world geopolitical risk (GPR), have a significant impact on the cointegrating coefficient. Our results imply that higher exposure of the US market to EPU, GPR and financial risk factors is a strong cause of bivariate market segmentation. Moreover, the specific economic and geopolitical situations of Canada and Japan make their bivariate equilibrium relations with the US more prone to segmentation. Further analysis of the time-varying cointegrating coefficients suggests that globalization is a potential factor that has restrained market segmentation during the last decade