Computing stock price comovements with a three-regime panel smooth transition error correction model

This paper studies the hypothesis of stock price comovements toward the US market for a large sample of developed and emerging stock markets (G6, BRICS, and MENA) over the periods of February 1970-June 2012, January 1995-June 2012, and June 2005-June 2012. To consider cross-market heterogeneity and asymmetrical time-variation in stock market integration, we propose an innovative threshold panel cointegration specification based on a panel smooth transitions error correction model. This specification enables us to identify different integration regimes that transit smoothly, which further reproduces the effects of market frictions and behavioral heterogeneity among the markets under consideration. Accordingly, we distinguish between efficient and inefficient market states. Further, we show that, while MENA and BRICS are segmented with the US market, a nonlinear mean-reversion of stock prices is observed for the G6 markets, suggesting evidence of heterogeneous threshold market integration. This suggests global diversification benefits from a US-MENA portfolio, while only per-regime investment opportunities appear for US-G6 and US-BRICS portfolios.