This paper empirically examines the short-run as well as long-run relationship of the Indian stock market with the major developed markets of the world during the period 2005-13. The objective of the analysis is to decide whether the financial recession of 2008 offers better diversification benefits to global investors through equity investments in India. The empirical results of Granger causality test find causality from the developed markets to the Indian market in the short run during pre- and post-crisis days. However, Johansen’s cointegration methodology fails to provide evidence of price integration among markets after recession and now the long run price movement in the Indian stock market is not driven by factors common to other markets. These findings confirm further possibilities of diversification to global investors through their equity investments in India.

Financial market liberalization has been the prime national agenda of the emerging economies in the last two decades. Slackening of regulations that inhibit foreign investments and developments in the field of information technology encouraged global investors to explore new investment opportunities in other parts of the world. The relaxation of policies by the host governments is expected to induce strong market integration, which would otherwise create enormous opportunities for domestic as well as global investors to diversify their portfolio. The nature and degree of market integration is also of considerable importance to corporate managers as it influences their cost of capital. It would also help in increasing savings and investments in the economy, a key determinant of growth and development.

The relationship among different stock markets has been of greater relevance in investment science. The diversification theory assumes that the prices of stock markets do not move together and investors can take advantage of global diversification through their concurrent investments in different markets. In another sense, when global stock markets fail to converge in their price movement, global investors can spread their investment risks across the economies of diverse countries, making it easier for the entire portfolio to weather an economic downturn in any of these countries. It generally claims that the countries with close trade and investment ties should have more tightly linked financial markets (Cheng and Zhang, 1997). But the market integration process leads to increased correlation between emerging markets and world markets and limits the potential of international diversification (Bekaert and Harvey, 2003). International investors, mostly from developed countries, are showing keen interest in emerging markets, but the interdependence of these markets and their integration with the developed markets may affect the scope for diversification possibilities (Pretorious, 2002). Emerging market economies are relevant to global financial markets, particularly when they experience financial crises, and with the bait of an abrupt portfolio rebalancing, they affect the investment decisions and returns in the markets of mature economies (Saez et al., 2009).

Applied Finance Journal, Global Financial Crisis, India’s Stock Market, Independent, US and Japan markets, Engel Granger Cointegration methodology, Dow Jones Industrial Average (DJ).