The dynamics of integration is studied in two time frames: short-term and long-term. The focus of this paper is to evaluate the short-term integration dynamics of stock exchanges of India (Bombay Stock Exchange – BSE) and China (Shanghai Stock Exchange – SSE) with US (S&P500) and Europe (FTSE100). Granger Causality Test was used to identify the direction of causality, and impulse response was used to identify the effect of shocks from one market to the other markets. The outputs suggest that BSE Granger-causes FTSE100 and S&P500. But SSE does not Granger-cause S&P500 and FTSE100. This result contradicts the findings of the prior research (Janak Raj and Sarat, 2008), which suggest that Indian stock markets do not Granger-cause US, European and other developed markets. The impulse response of S& P500 to BSE suggests that any shocks from BSE to S&P500 survive for a period of two days. This study would help portfolio managers and investors to view diversification from a new perspective and take advantage of it.

With the opening of the economy, a country’s market provides opportunities for both domestic as well as foreign market participants to offer cross-border trade and other services. Therefore, the integration process eliminates barriers for market participants. This implies that the more open an economy is, the more is the degree of integration. Hence, integration of stock markets can be defined as “assets with same level of risk should be equally priced taking riskadjusted return into consideration. Integration process takes place in two dimensions: horizontal and vertical” (USAID, 1998). Horizontal integration suggests integration among domestic stock markets, while vertical integration is the integration of domestic stock markets with foreign stock markets. A well-integrated market also brings efficiency to the market by increasing its depth and breadth. It also helps in increasing the liquidity of the market. A portfolio manager tries to identify the degree of integration between different stock markets to diversify his portfolio (Sentana, 2000) as well as to take the benefit of arbitrage, if any. Integration process also helps in reducing the cost of trade between markets (Levine and Zervos, 1996; and Caprio and Honhan, 1999) and hence, from all dimensions, stock market integration helps in improving the efficiency of the stock markets (Agnor, 2001).

After the recent financial crisis centered in the US and then moving to Eurozone (though with a different name ‘Debt Crisis’), once again this subject has attracted the attention of researchers and practitioners. Some of the practitioners are of the opinion that the financial center of the world is making a shift from West to East.

Moreover, integration can help in the process of making a country an international financial center by providing necessary conditions (Reddy, 2003 and 2006). Hence, it becomes interesting to identify the relationship between stock exchanges of developed and developing countries. This paper examines the integration of stock exchanges of India (Bombay Stock Exchange – BSE) and China (Shanghai Stock Exchange – SSE) with US (S&P500) and Europe (FTSE100).

Applied Finance Journal, Bombay Stock Exchange (BSE), Shanghai Stock Exchange – (SSE), Augmented Dickey-Fuller (ADF), Short-Term Integration, Dynamics of Developing, Developed Stock Markets, Evidence, India, China, US, European Markets.