STOCK MARKETS VOLATILITY IN THE CZECH REPUBLIC, CROATIA AND SELECTED EU-COUNTRIES 1

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1 STOCK MARKETS VOLATILITY IN THE CZECH REPUBLIC, CROATIA AND SELECTED EU-COUNTRIES 1 Lumír Kulhánek Silesian University in Opava School of Business Administration in Karviná, Department of Finance Univerzitní nám. 1934/ Karviná Czech Republic kulhanek@opf.slu.cz telephone: Abstract In this paper, first, we will take notice of the development of the stock markets in Croatia and in the Czech Republic. Subsequently, a comparison of volatility will be made with the development of the stock markets in three selected countries of the European Union (France, Germany, Great Britain), where only France and Germany are part of the euro area. Both main quantitative characteristics of the development of stock market indexes will be analyzed (monthly returns and risk), as well as the correlation of returns and changes in the correlation of returns among particular countries. The comparison of monthly returns and risks on stock markets in the Czech Republic, Croatia and three developed EU-Countries in examined period from 1997:1 to 27:2 has confirmed characteristics which are typical for the emerging markets. Returns and risk are higher than in returns and risk in developed stock markets. The increase of returns in all examined stock markets was connected in examined period with the decrease of risk. Keywords: Stock Markets Returns, Risk, Portfolio Diversification, Emerging Markets JEL codes: F36, G15 1. Introduction At present, we are witnesses of the integration process of the national financial markets towards the worldwide, global financial market. Investors tend not to make a distinction between national and foreign financial instruments; banks operate in the worldwide area. For these reasons, the motives for international investing are examined along with advantages and disadvantages regarding the strategy of international investing on the stock markets. With reference to this fact, it is necessary to pay attention to the development 1 The paper is published with the support of the Grant Agency of the Czech Republic Project No. GACR 42/5/2758 Integrace finančního sektoru nových členských zemí EU do EMU. 453

2 of the emerging stock markets. There are a great number of reasons for this research. Among the main ones can be ranked the fact that globalization tendencies lead to the integration of the closed economies into the international capital flows, capital markets have arisen in the transforming economies and the extension of activities of the private investors have taken place. The increase in demand for cross-border investment stocks within the euro area brings about considerable changes in the market structures, both on exchange-traded markets and in brokerage industry. These changes occur not only in the euro area market structures, but rather on a European Union level. In this paper, first, we will take notice of the development of the stock markets in Croatia and in the Czech Republic in the period from 1997 to 27. Subsequently, a comparison of stock market returns volatility will be made with the development of the stock markets in three selected developed countries of the European Union (France, Germany, Great Britain), where only France and Germany are part of the euro area. Both main quantitative characteristics of the development of stock market indexes will be analyzed (monthly returns and risk), as well as the correlation of returns and changes in the correlation of returns among particular countries. 2. The Development of Equity Indices 2.1 Data The analysis of the stock markets development and their international comparison are made by applying monthly national equity indices for the Czech Republic (PX), Croatia (CROBEX), France (CAC 4), Germany (DAX) and United Kingdom (FTSE 1). The period from December 1996 to February 27 is examined, and for monthly returns the period from January 1997 to February 27. For more detailed analysis, this period is also divided into two sub periods the first one from December 1996/January 1997 to December 21, and the second one December 21/January 22 to February 27. Monthly stock market indexes are end-of-period for all countries in the domestic currency. 2 Analyses for this paper have been carried out on the basis of stock market indexes in the local currencies, since the primary objective was to depict the development of the national stock markets and not the aspects of the international portfolio diversification. 2 Data are own calculations based on data from history.php?, 454

3 2.2 The development of stock markets in the years The developments of particular stock markets in the examined countries from December 1996 to February 27 are showed in Figure 1. As it is apparent from the Figure 1, the increasing trend of developed stock markets (with a decrease in the year 1998) was replaced from the beginning of the year 2 by a plunge continuing up to the first quarter of the year 23. Decreasing trend of Croatian stock market was replaced from the third quarter of the year 1999 and in the Czech Republic from the third quarter of the year 21. Yet, in the Czech Republic and Croatia we can notice the stoppage of the decrease or a mild recovery of the stock market as early as in the last quarter of the year 21. Figure 1 Development of stock market indexes (1997:3-26:5) :1 98:1 99:1 :1 1:1 2:1 3:1 4:1 5:1 6:1 7:1 PX CROBEX CAC DAX FTSE Source: Own calculations based on com /intlindices. The detailed examination of the development of stock indexes in the period of 1997:1-21:12 is represented in Figure 2, from which a relative synchronous development of the stock markets in the Czech Republic, France, Germany and the United Kingdom is evident. The highest increase in the monthly index in that period 1997:1-21:12 was registered in the Czech Republic (May 1999: +2,5 %) and Croatia (September 1998: + 19,2 %), the highest decrease in Croatia too (August 1998: -54 %). France recorded in this period the highest monthly increase of +13,2 % (June 1997), Germany +16,7 % (December 1999) and United Kingdom 8,5 % (January 1998). The highest decrease France recorded in 455

4 September 21 (- 14 %), Germany in August 1998 (-2,6 %) and United Kingdom in August 1998 (-12,6 %). Figure 2 Development of stock market indexes (1997:1-21:12) :1 97:7 98:1 98:7 99:1 99:7 :1 :7 1:1 1:7 2:1 CZE1 CRO1 FRA1 GER1 UKI1 Source: Own calculations based on com /intlindices. As it is apparent from the Figure 2, starting in October 1998 the stock markets began to turn up; starting in March 2 the equity markets in the Czech Republic, Germany and United Kingdom began to turn down. Figure 3 represents the development of stock markets in the second sub period of the examined period in the period of 22:1 to 27:2. A characteristic feature for this period is first stagnation and subsequently the slump of stock indexes practically in all examined countries except Czech Republic (starting in September 21 the Czech stock market began to turn up). The decreasing trend of developed stock markets and Croatian stock market was replaced from the first quarter of the year The highest monthly increase in the stock market index in that period 22:1-27:2 was registered in Croatia (January 25: +2,6 %) and Germany (April 23: +19,2 %), the highest decrease in Germany (September 22: -28,8 %) and France (September 3 Accession countries that joined EU in 24 had a big increase in values of their stock indices (Broz and Ridzak, 26). Dvorak and Podpiera (25) claim that price increase of equities in the EU accession countries, that happened after accession was certain, has been caused by increased market integration. 456

5 22: -18,1 %). The highest decrease in United Kingdom (-12,7 %) was registered in September 22 too. Figure 3 Development of stock market indexes (22:1-27:2) :1 2:7 3:1 3:7 4:1 4:7 5:1 5:7 6:1 6:7 7:1 CZE1 CRO1 FRA1 GER1 UKI1 Source: Own calculations based on com /intlindices. 3. Monthly Returns and Risk 3.1 Comparison of returns and risk for the period 1998:1-27:2 Main characteristics of the monthly returns of the national stock markets in Croatia, Czech Republic, France, Germany and Great Britain (mean of returns and standard deviation of returns) and also other characteristics for the entire period of 1997:1 27:2 are depicted in Table 1. The data confirm general assertions that emerging markets (or stock markets in transition countries) not only may offer higher returns, but also the risks associated with returns are frequently higher than in the established markets as well. 4 The highest average monthly return in period of 1997:1 27:2 was registered in Croatia (it amounted to 1,9 %), the Czech stock market recorded in this period average monthly return,91 %. Developed stock markets in France, Germany and United Kingdom recorded in this period lower average monthly returns (from,34 % to,71 %). The volatility 4 For the Czech Republic, Poland and EMU-Countries see Kulhánek (25), among others. 457

6 of the monthly returns is in emerging markets generally high (standard deviation 8,84 for Croatian stock market and 6,91 for Czech stock market in comparison with 4,16 for United Kingdom or 5,99 for France). In cases of some countries it can be noticed with Kulhánek and Uherek (23) that a higher risk does not have to be accompanied by higher returns (returns and risk at German stock market in comparison with stock markets in Czech Republic or France, see Figure 4). Table 1 Selected characteristics of monthly returns (1997:1-27:2) Croatia Czech Rep. France Germany U. Kingdom Mean Median Maximum Minimum Std. Deviation Skewness Kurtosis Jarque-Bera Probability Sum Sum sq. dev Observations Source Author s calculation Figure 4 Risk and monthly returns (1997:1 27:2) Monthly returns Std. Deviation Mean Std. Dev.. CRO CZE FRA GER UKI. Source Author s calculation 3.2 Development of risk and monthly returns The comparison of the development of risk and monthly returns of particular countries brings remarkable results too. For the purposes of this comparison, the five-years moving 458

7 averages of risk and monthly returns for Croatian, Czech, German and British stock markets were obtained, which are showed in Figure 5 and Figure 6. Figure 5 Development of five-years moving averages of risk and returns for Czech and Croatian stock markets (21:12 27:2) Czech Republic 12 Croatia :1 2:7 3:1 3:7 4:1 4:7 5:1 5:7 6:1 6:7 7:1-1 2:1 2:7 3:1 3:7 4:1 4:7 5:1 5:7 6:1 6:7 7:1 Monthly returns Risk (5-years moving averages) Monthly returns Risk (5-years moving averages) Source Author s calculation Figure 6 Development of five-years moving averages of risk and returns for German and British stock markets (21:12 27:2) 1. Germany United Kingdom :1 3:1 4:1 5:1 6:1 7:1 Monthly returns Risk (5-years moving averages) 2:1 3:1 4:1 5:1 6:1 7:1 Monthly return Risk (5-years moving averages) Source Author s calculation The monitoring of monthly returns and risk development (measured by five-years moving averages of monthly returns and standard deviation) and their international comparison prove in principle the fundamental relation between returns and risk. As it is 459

8 obvious from Figures 5 and 6, the increase of monthly returns was connected with the decrease of standard deviation. Correlation coefficients between five-years moving averages of monthly returns and standard deviations are -,898 for Croatia, -,957 for Czech Republic, -,773 for Germany and -,622 for United Kingdom respectively. Similar relatively high average monthly returns of the Croatian or Czech stock markets were related to the high risk (or standard deviation) in comparison with the United Kingdom. Then again, the British stock market showed the lowest average monthly return and the lowest standard deviation. 4. Stock markets linkages Since the sixties the advantages of the international diversification have been analyzed in detail. The results of a number of empirical studies in this area indicate that the benefits from the international diversified portfolios arise from a relatively low interconnection of the individual national stock markets, which is assessed according to the correlation coefficients of proceeds rate among those national stock markets. A question arises legally in connection to the aim of the paper too, what degree of interdependence stock markets in the old and new EU-countries show. Due to the changeable character of the development of stock markets, the valuation of mutual relations between the developments of the particular national stock markets was conducted in two steps. First, the correlation 5 coefficients of monthly returns for the entire observed period from 1997:1 to 27:2 were identified (see Table 2). Subsequently, the correlation coefficients were identified as five-years moving averages beginning from December 21 to February 27 (see Figures 7 and 8). As it is noticeable from Table 2, high correlation coefficients are (traditionally) 6 showed by the returns of developed stock markets (Germany and France:,95, Germany and the United Kingdom:,798). Correlation coefficients of these stock markets with Croatia and Czech Republic are considerably lower (between,268 and,421). Monthly returns of the Croatian stock market in examined period are mostly correlated with British stock market 5 Adam, Jappelli, Menichini, Padula and Pagano (22) use price-based and quantity based indicators in order to assess evolution of capital market integration within European Union. As price-based indicator for stock markets they use correlation of stock market returns. 6 See Kulhánek (22). 46

9 (,421) and Czech stock market (,381) respectively. Correlation coefficients of Czech stock market returns with developed stock markets in EU-Countries are lower too. Table 2 Correlation coefficients of the monthly returns for the sample period Croatia Czech Rep. France Germany U. Kingdom Croatia Czech Republic France Germany United Kingdom Source: Author s calculation As it apparent from the Figure 7, changes of five-years moving averages of correlation coefficients for Czech and Croatian stock markets returns against average are obvious in the course of time. The correlation coefficient between Czech and Croatian markets showed first an increase of correlation coefficients till the April 22, then it was followed by the decrease up to August 23, and subsequently the correlation coefficient began to oscillate. Increase of correlation coefficient began from June 24 and the most correlated returns of these stock markets come around starting November 25. The development of five-years moving correlation coefficients for France, Germany and United Kingdom is depicted in the right part of Figure 7. Figure 7 Correlation of monthly returns for selected countries (21:12 27:2) CZE_CRO CZE_GER CZE_CRO average CZE_GER average FRA_GER GER_UKI FRA_UKI CZE_GER average Source: Author s calculation The development of five-years moving correlation coefficients for the Croatian both Czech stock markets against the British stock market is depicted in the left part of Figure

10 Development trends of correlation coefficients against German stock market are obvious from the right part of this Figure. Figure 8 Correlation of monthly returns against British and German stock markets (21:12 27:2) CRO_UKI CZE_UKI CRO_GER CZE_GER Source: Author s calculation As is apparent from the Figure 8, started in 23 for the Czech stock market both Croatian stock market the increase from the lowest levels of correlation coefficients against British stock market was marked and the decrease against German stock market. 5. Conclusion This paper focuses on the development of the stock markets in Croatia and in the Czech Republic in comparison with the development of stock markets in selected developed EU-Countries. The comparison of monthly returns and risks on stock markets in the Czech Republic and Croatia in examined period from 1997:1 to 27:2 has confirmed characteristics which are typical for the emerging markets. Returns and risk are higher than in returns and risk in developed stock markets. The increase of returns in all examined stock markets was connected in examined period with the decrease of risk. The monthly returns correlation coefficients for Croatia and Czech Republic against developed stock markets are generally positive but low. This fact can contribute to the decrease in portfolio risk by way of international diversification. However our results confirms, that correlation is a time-varying short-term measure and portfolios built 462

11 accordingly may underestimate long term gains and require frequent rebalancing. Stock markets returns in Croatia and Czech Republic have become increasingly interconnected from end of the year 25. References [1] ADAM, K., JAPPELLI, T., MENICHINI, A., PADULA, M., PAGANO, M. (22) Analyse, Compare, and Apply Alternative Indicators and Monitoring Methodologies to Measure the Evolution of Capital Market Integration in the European Union. Salerno: Centre for Studies in Economics and Finance, University of Salerno, 22. Access from: < pdf > [2] BROZ, T., RIDZAK, T. Croatian Equity Market in Perspective of European Integration. Dubrovnik: 12th Dubrovnik Economic Conference, 26. Access from: < > [3] DVORAK T., PODPIERA R. European Union Enlargement and Equity Markets in Accession Countries (ECB Working Paper Series No. 552, November 25). Frankfurt: European Central Bank, 25. Access from: < ecbwp552.pdf > [4] KULHÁNEK, L. Comparison of Capital Markets Returns in the Czech Republic and in the EMU. In Finance. 5th Anniversary Financial Conference. Svishtov-Veliko Tarnovo: Abagar, 22, pp ISBN [5] KULHÁNEK, L. Stock Markets in Poland and Czech Republic. In CZEKAJ, (ed.) Kapitał i Ŝródła jego pozyskiwania dla przedsiębiorstw i regionów. Bielsko-Biała: WyŜsza Szkoła Bankowości i Finansów, 25, pp ISBN ISBN X. [6] KULHÁNEK, L., UHEREK, D. Globalization, Financial System and Equity Market Linkages in Transition Countries. Economic Research (Ekonomska Istraživanja). 23, vol. 16, no. 2, pp