Are socially responsible investment markets worldwide integrated

Description
This study seeks to investigate the extent and structure of equity price interdependence
among the socially responsible investment (SRI) markets of Australia, Canada, Japan, UK and USA
over the period 1994-2010

Accounting Research Journal
Are socially responsible investment markets worldwide integrated?
Eduardo Roca Victor S.H. Wong Gurudeo Anand Tularam
Article information:
To cite this document:
Eduardo Roca Victor S.H. Wong Gurudeo Anand Tularam, (2010),"Are socially responsible investment
markets worldwide integrated?", Accounting Research J ournal, Vol. 23 Iss 3 pp. 281 - 301
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Richard Copp, Michael L. Kremmer, Eduardo Roca, (2010),"Should funds invest in socially responsible
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Accounting Research J ournal, Vol. 23 Iss 3 pp. 254-266http://dx.doi.org/10.1108/10309611011092583
Robert J . Bianchi, Michael E. Drew, Adam N. Walk, (2010),"On the responsible investment disclosure
practices of the world's largest pension funds", Accounting Research J ournal, Vol. 23 Iss 3 pp. 302-318http://dx.doi.org/10.1108/10309611011092619
Clevo Wilson, (2010),"Why should sustainable finance be given priority?: Lessons from pollution
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Are socially responsible
investment markets worldwide
integrated?
Eduardo Roca and Victor S.H. Wong
Department of Accounting, Finance and Economics,
Grif?th Business School, Grif?th University, Nathan, Australia, and
Gurudeo Anand Tularam
Faculty of Science, Engineering, Environment and Technology,
Grif?th University, Nathan, Australia
Abstract
Purpose – This study seeks to investigate the extent and structure of equity price interdependence
among the socially responsible investment (SRI) markets of Australia, Canada, Japan, UK and USA
over the period 1994-2010.
Design/methodology/approach – The paper examines the degree of price co-movement between
SRI markets by using a vector autoregression analysis to identify the markets which have signi?cant
price co-movements. Subsequently, a variance decomposition analysis is conducted among the
markets which are signi?cantly related in order to determine the extent of interaction between these
markets and to identify the markets that are most and least in?uential.
Findings – The results show that the SRI markets are signi?cantly interdependent and have become
more so over the years. The USA and the UK are the markets most linked to others while Canada and
Australia are the most in?uential. However, although the markets are signi?cantly integrated, the
level of integration is still at a low level.
Originality/value – This is the ?rst known study to examine price linkages among international
SRI markets. This knowledge is important for investors as the bene?ts from international
diversi?cation depends on the extent of linkages between different SRI markets. Such knowledge is
also valuable for policymakers and regulators if they are to address international contagion risk
between markets. The study found that SRI markets are signi?cantly linked; however, the level of
linkages is still at a relatively low level. This implies that there are still signi?cant bene?ts to be
derived by SRI investors through international diversi?cation.
Keywords Social responsibility, Investment, Integration
Paper type Research paper
1. Introduction
Socially responsible investment (SRI) is a form of investment that combines the pursuit
of ?nancial returns and non-?nancial – such as environmental, social, and governance
(ESG) considerations. It is claimed that the pursuit of non-?nancial factors provide SRI
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1030-9616.htm
The authors are grateful for comments received from the two referees and from the participants
of the 16th Conference on the Theories and Practices of Securities and Financial Markets held on
December 5-8, 2008 at National Sun Yat-Sen University, Kaohsiung, Taiwan, and the Annual
International Conference on Finance, Accounting, Investment and Risk Management 2009 held
at the Gold Coast, Australia. They also thank Ms Jane Li for providing research assistance and
comments to this paper.
SRI markets
281
Accounting Research Journal
Vol. 23 No. 3, 2010
pp. 281-301
qEmerald Group Publishing Limited
1030-9616
DOI 10.1108/10309611011092600
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investors with extra utility or satisfaction. There is also the belief by SRI investors that
ESG factors materially affect the returns in a positive way that can lead to lower cost
arising from the avoidance or minimisation of environmental and reputational risk,
better management and better customer satisfaction that leads to higher revenues
(Renneboog et al., 2006, 2008). However, due to these extra considerations, there is a
reduction in the investment universe of the SRI investors which results in a more
limited diversi?cation for SRI investors.
One way to alleviate this problem of limited diversi?cation is for SRI investors to
undertake international diversi?cation across SRI markets worldwide. This is now an
opportunity that is available to SRI a?cionados. SRI is now a very signi?cant form of
investment around the world. Over the past three decades, SRI has grown tremendously
and expanded globally[1]. This massive growth in SRI is being fuelled by the increasing
involvement of large institutional investors such as pension and mutual funds, and other
traditional ?nancial services providers. Global organisations such as the UN Principles
of Responsible Investment, UN Environmental Programme, Global Compact, among
others, have also signi?cantly boosted the growth of SRI as these organisations now
command the membership of huge global ?nancial institutions and institutional
investors who pledge to promote SRI. The interest andsupport for SRI has also generated
the creation of speci?c share indices such as the DowJones sustainable index (DJSI) and
FTSE4GOOD as well as specialised research houses such, among others, Morningstar
and Sustainable Investment Research Institute to support the growth of the industry.
A crucial factor that determines the bene?ts for SRI investors from international
diversi?cation is the extent of integration or linkages among SRI markets. According to
international portfolio diversi?cation theory, the lower (higher) the extent of linkages
between markets, the greater (smaller) the bene?ts from international diversi?cation.
However, there is no clear understandingyet as regards the extent of linkages amongSRI
markets worldwide. There are now a number of studies on SRI which have investigated
the following aspects of SRI – performance (Luther et al., 1992; Hamilton et al., 1993;
Gregory et al., 1997; Russo and Fouts, 1997; DiBartolomeo and Kurtz, 1999; Statman,
2000; Orlitzky et al., 2003; Bauer et al., 2005; Kreander et al., 2005; Hong and Kacperczyk,
2006; Bauer et al., 2007; Edmans, 2007), ratings (Angel and Rivoli, 1997; Lee and Ng, 2002;
Guenster et al., 2005), and screenings (Guerard, 1997). None of these studies, however,
have focused on the linkages or spill-over between SRI markets. This paper, therefore,
addresses this gap in the SRI literature. It analyses the extent of integration between the
SRI markets of Australia, Canada, Japan, the UK, and the USA. In particular, it examines
the extent, speed, and duration of interaction among these SRI markets.
This paper, therefore, provides knowledge on the extent of integration among SRI
markets. As previously mentioned, this knowledge is highly important to SRI investors
if they are to diversify internationally across SRI markets. Additionally, this knowledge
is also of value to regulators. If SRI markets are found to be closely linked or integrated,
then there is the risk of shocks in one SRI market spilling over to another SRI market –
creating contagion risk which regulators will have to address. This paper contributes to
the academic literature as it is the ?rst known SRI study that examines this issue.
Furthermore, this study also contributes to the literature on international ?nancial
market integration. There are nowa voluminous number of studies whichhave examined
the issue of international integration among equity, bonds, and money markets
(Panopoulou and Pantelidis, 2009; Chi et al., 2006; Click and Plummer, 2005; Roca, 1999).
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However, there is no consensus amongthese studies as to whether markets are integrated
or not. Some studies have revealed that markets are integrated while other studies found
the opposite depending on the type of market studied, and the time period and data used.
This paper, therefore, provides further evidence on the issue of ?nancial integration
based on a market, i.e. SRI, which is deemed to be different from those which have been
studied by the existing literature.
Studies on equity market integration have primarily examined the following issues:
.
whether equity markets are integrated or segmented;
.
whether the linkage between equity markets are stable or unstable;
.
whether there are groupings among markets in terms of linkages; and
.
the manner of interaction among equity markets – which markets are in?uential,
how one market affects another market and the speed of interaction among
markets.
As mentioned earlier, the results of these studies are mixed. Some have concluded that
equity markets are integrated (see, for instance, Agmon, 1972; Ripley, 1973; Hillard,
1979; Ibbotson et al., 1982; Jaffe and Wester?eld, 1985; Schollhammer and Sand, 1987;
Wheatley, 1988; Hamao et al., 1990; Espitia and Santamaria, 1994; among others). Other
studies reported that equity markets are segmented (Grubel, 1968; Makridakis and
Wheelwright, 1974; Adler and Dumas, 1983; Jorion and Schwartz, 1986; Levy and
Lerman, 1988; Dwyer and Hafer, 1988; Jorion, 1989; Smith et al., 1995). With respect to the
stability of equity market linkages, again, the results of previous studies are divergent.
Some studies found equity market linkages to be stable (Panton et al., 1976;
Philippatos et al., 1983; Goodhart, 1988; among others). Others claim that linkages
among equity markets are unstable (Maldonado and Saunders, 1981; Roll, 1989a, b).
Anumber of studies have examined the manner of interaction among equity markets
in terms of the in?uence of one market over the other, the manner of response of markets
to in?uences coming from other markets, and the speed by which shocks or volatility
from one market is transmitted to other markets. There is overwhelming evidence that
the USA equity market is the most in?uential stockmarket in the world (Khoury et al.,
1987; Schollhammer and Sand, 1987; Fischer and Palasvirta, 1990; Espitia and
Santamaria, 1994).
Considering that the Japanese equity market is the second largest in the world (in fact,
historically, it was the largest for a number of years), there is the expectationthat it would
at least exert signi?cant in?uence on other markets, particularly in the Asia Paci?c. The
results from previous studies do not provide a clear answer. Lee (1992), after analysing
the relationship between the stockmarkets of Japan, Korea, Taiwan, Hong Kong, and
Singapore using monthly data from January 1970 to December 1989, concluded that
Japan is not an in?uential market. Becker et al. (1990) and Jaffe and Wester?eld (1985)
reported that the Japanese equity market had only a small impact on the US stockmarket
during the period 1985-1988. On the other hand, Jeon and von Furstenberg (1990) and
Hamao et al. (1990) had found the Japanese market to be less interdependent with the US
stockmarket since the crashof October 1987. To et al. (1994), however, foundthe Japanese
equity market to be in?uential on the Asian emerging markets.
With regards to the existence of leads and lags among markets, the overwhelming
evidence is that the US leads other markets, with the exception of such markets as Korea,
SRI markets
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Taiwan, and Thailand (Khoury et al., 1987; Eun and Shim, 1989; Fischer and Palasvirta,
1990). There are, however, some studies that reported no lead/lag relationships among
markets (Granger and Morgenstern, 1970; Hillard, 1979). It is interesting to note that
some studies also reported that smaller markets do in?uence the US markets. For
instance, in a study of the interaction among national equity markets, Huyghebaert and
Wang (2010) found that Singapore and Hong Kong Granger-cause the USA in their
study of equity markets.
On the issue of transmission of shocks between markets, the results of previous other
studies have also been mixed with some reporting that the transmission process is
ef?cient, i.e. occurring within a period of one to two days (Schollhammer and Sand, 1987;
Khoury et al., 1987) while other studies (Ng et al., 1991) reported the process to be
inef?cient.
Some studies point to the existence of a linkage between certain groups of equity
markets based on some unifying or common factor, such as close regional, economic,
and geographical relationships. To et al. (1994) found the following clusters: Japan and
Asian emerging markets, and the UK and African emerging markets. Hillard (1979)
discovered a close association among intra-continental markets during the oil crisis of
1973 while Jorion (1989) reported a high degree of linkage among European continental
markets. An Anglo-Saxon cluster was also reported by Jorion (1989).
In summary, this paper, therefore, provides knowledge on the extent of integration
and linkages amongSRI markets worldwide. In doing so, the study extends the literature
in SRI and ?nancial market integration. It also provides practical contributions to
investors and policymakers as knowledge of the linkages among SRI markets would be
highly important to them.
The remaining parts of this paper are organised as follows. Section 2 provides a
further background of SRI. Section 3 presents a brief discussion of the data and
methodologies employed in the study. Section 4 presents the empirical results followed
by the conclusion in Section 5.
2. Institutional background
SRI is a broad term to describe an investment process, which takes environmental,
social, ethical, and/or governance considerations into account. This process stands in
addition to or is incorporated into the usual fundamental investment selection and
management process. SRI has a long history dating back to the eighteenth century that
begins with religious groups such as the Quakers and Methodists who initiated this
type of investing. Since the late 1960s the focus and support for SRI has expanded, the
expansion was driven by a number of factors such as the rise of the civil rights
movement, environmentalism and concerns about globalisation (Kinder et al., 1993).
In recent years, supra-national bodies have been formed such as the Global Reporting
Initiative, United Nations Environment Programme, and United Nations Principles for
Responsible Investment, among others. This development, jointly with the progress of
corporate initiatives towards environmental and social impact information disclosure
eventually created fertile ground for the SRI markets (SIF-J, 2007).
SRI differs from conventional investments in several ways. First, SRI is targeted at
companies that adhere to the ESGrequirements or screens as determined by these funds.
There are three dominant SRI screening practices employed today, i.e. negative, positive,
and the best of sector screens. Each of these has been described by Lee (2006) as follows:
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.
Negative or exclusionary SRI screens typically seek to exclude companies based
on a set of social and environmental criteria. They commonly screen out so-called
“sin stocks” such as companies dealing with alcohol, tobacco, weapons, gambling,
uranium, and pornography. This is the most common method of screenings that
is relatively easy to implement and administer.
.
Positive screens seek to promote and select companies based on their
demonstrated ability and commitment to social and environmental issues. This
screening is much broader with respect to the range of companies, industries, and
countries that can be included in an investor’s SRI portfolio. Also, it allows fund
managers and investors an increased selection of securities across a range of
industries and countries that otherwise would not have been available if negative
screenings were employed. As such, positive screens increase one’s investment
opportunity set and thus returns potential whilst allowing for greater levels of
adequate diversi?cation. This may include water and waste management,
renewable energy and energy ef?ciency, sustainable agriculture, mass transport,
sustainable property, education, aged care, and health care.
.
Another type of inclusive screen, like the positive SRI screen, is the best of sector
approach. This process involves identifying leaders that are taking their industry
towards a sustainable future. The approach is based on the premise that
companies with strong sustainability credentials are generally better managed
companies, and therefore better investments. This strategy is also a more
inclusive SRI screen in that it favours those companies with the best social and
environmental performance within each economic sector. Best of sector screening
requires a very detailed country, industry, and company analysis to determine
which ?rms lead their respective industries with regard to social, environmental,
and economic performance criteria.
The effect of these ESG screens on the performance of portfolios is one that is debated
within the investment management literature. On one hand, it is suggested that these
additional screens have positive impact oninvestors in terms of additional (Tippet, 2001)
and higher returns. Investors in SRI are thought to derive non-?nancial utility that
correspond to their moral preferences. These screens are also considered to represent an
active selection strategy of ?rms with characteristics that are believed to yield superior
performance (Bollen, 2007). The incorporation of ESG issues by these ?rms are thought
to lead to lower cost of capital arising from the minimisation or avoidance of such risks
as environmental risk and reputation risks. It is also claimed that these ?rms are better
managed, and that they take more consideration of the welfare of their customers, which
then lead to increased revenues and higher returns (Renneboog et al., 2006). On the other
hand, it is argued that the exclusion of companies that fail these criteria may reduce the
diversi?cation possibilities and negatively in?uence the performance of the SRI funds in
comparison to conventional funds. Further, it is also contended that the use of the
additional screens can result in additional costs which can result in lower net returns
(Mill, 2006; Jones et al., 2008). The bulk of the evidence on the performance of SRI seems
to show that there is no signi?cant difference in performance between SRI and
conventional investment (Renneboog et al., 2008).
From the point of view of investment management, it appears, therefore, that the
main concern with SRI relates to its more limited diversi?cation which can negatively
SRI markets
285
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affect returns. As mentioned earlier, given the very substantial growth of SRI markets
over the last three decades which have now resulted in the existence of signi?cant SRI
markets worldwide, there is an opportunity to alleviate this problem through
international diversi?cation. The pursuit of this strategy necessitates knowledge of the
linkages between different SRI markets worldwide as the size of the bene?ts from
international diversi?cation is dependent on the extent of linkages between markets.
This paper, as stated earlier, addresses this issue. It examines the price integration and
linkages among major SRI markets worldwide represented by Australia, Canada,
Japan, the USA, and the UK over the period 1994-2010.
3. Empirical speci?cations and data
Integration entails the equality of price or risk-adjusted returns[2]. It also implies
co-movements in prices. Investigating integration based on price or risk-adjusted
returns requires the use of asset pricing frameworks. The employment of asset pricing
models, however, creates dif?culty in examining ?nancial integration. For example, if
no integration is found, this can mean either that there is indeed no integration at all or
that the asset-pricing model employed is not valid. To avoid this problem, this paper
examines integration based on co-movement of prices. The higher the co-movement of
prices and the faster the response of prices in one market to the movements of prices in
the other market, the greater the degree of integration. Thus, in this paper, we examine
the integration between SRI markets through an analysis of the extent, duration, and
speed of interaction among the SRI markets.
In order to gauge the degree of price co-movement between SRI markets, we ?rst
conduct a vector autoregression (VAR) analysis to identify the markets which have
signi?cant price co-movements. Then, we perform the variance decomposition (VDC)
analysis among the markets, which have been identi?ed to be signi?cantly related to
determine the extent of interaction between these markets and to identify which
markets are the most and least in?uential. Finally, in order to measure the duration and
speed of interaction between the markets, we undertake an impulse response analysis.
We provide in the ensuing paragraphs further details on the VAR, VDC, and impulse
response analyses. Since each of these techniques are now well-known in the literature,
we only provide a brief discussion of each. For readers who are interested in more
detail, we refer them to the relevant materials which we cite.
We perform a VAR analysis (Sims, 1980) in an unrestricted reduced form equation
system. We estimate a ?ve-market VAR system represented by equation (1) below:
R
t
¼ a þ
X
L
k¼1
b
k
R
t2k
þ1
t
ð1Þ
where R
t
is a 5 £ 1 column vector of weekly SRI market returns, a and b
k
are 5 £ 1 and
5 £ 5 matrices of coef?cients, respectively, L is the lag length and 1
t
is a 5 £ 1 column
vector of serially uncorrelated error terms, The i, jth component of b
k
measure the
direct effect on the ith market of a change in the return to the jth market in the k
periods. In effect, the ith component of 1
t
is the innovation of the ith market which
cannot be predicted from past returns of other markets in the system.
More generally, a VAR( p) may be written as y
t
¼ F
i
x
0
t
þ u
t
where t ¼ 1; 2; . . . ; n; y
t
is a m £ 1 vector, x
t
¼ ð1; x
t
¼ ð y
t
; y
t21
; . . . ; y
t2p
ÞÞ and F
i
; i ¼ 0; 1; 2; . . . ; p; and u
t
is
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white noise with covariance matrix S. The variables are stationary and the regressors
are not perfectly collinear. Under certain conditions (Bruggemann et al., 2008),
the MA(1) version of the VAR may be written as:
y
t
¼
X
1
i¼0
B
i
u
t2i
where B
j
¼ B
j21
F
1
þ B
j22
F
2
þ · · · þ B
j2p
F
p
where j ¼ 1; 2; . . . ;with B
0
¼ I
m
; and
for j , 0, B
j
¼ 0. There are in fact two ways of investigating VDC and since the ?rst
orthogonal method is well known it is not reviewed. The second generalised version
involves forecast at t þ N conditional on data available at t 2 1 and the error in
predicting y
tþN
is given by:
1
t
ðNÞ ¼
X
N
i¼0
B
i
u
tþN2i
where 1
t
ðNÞis a m by 1 matrix and the total forecast error covariance is a
Cov½1
i
ðNÞ? ¼
P
N
i¼0
B
i
SB
0
i
. It is important now to consider the forecast error covariance
matrix of predicting y
tþN
conditional on information at t 2 1 and given values of the
shocks to the jth equation ðm
ijt
; m
jtþ1
; . . . ; m
jtþN
Þ.
Given:
1
ð j Þ
t
ðNÞ ¼
X
N
i¼0
B
i
ðu
tþN2i
2E½m
tþN2i
jm
j tþN2i
?Þ
and assumingm
j
< Nð0; SÞ, the expectation is given as E½m
j
jm
jt
¼ d
ji
? ¼ ðs
1j
; s
2j
; A
; s
Nj
Þ
0
s
21
jj
d
j
where d ¼ s
2ð1=2Þ
jj
is for one standard deviation shock.
E½m
tþN2i
jm
jtþN2i
? ¼ ðs
21
jj
Se
j
Þm
jtþN2i
for i ¼ 1; . . . ; N while j ¼ 1; . . . ; m; with e
j
being m £ 1 and all element being zero except jth that is one.
Substitution into the earlier equation and taking expectation gives:
Cov½1
ð j Þ
ðNÞ? ¼
X
N
i¼0
B
i
SB
0
i
2s
21
jj
X
N
i¼0
B
i
Se
i
e
0
i
SB
0
i
" #
ð2Þ
Conditioning future shocks to jth equation allows decreasing variance in an N step
forecast, and the second term in the covariance equations gives the lowering of the
variance over forecast steps. Finally, scaling the kth term in the sequence with jth
variance provides the formulae for the generalised forecast error VDC as employed in
this study (Ewing, 2001):
G
kjN
¼
s
21
jj
P
N
i¼0
ðe
0
k
B
i
Se
j
Þ
2
P
N
i¼0
½e
j
B
i
SB
0
i
e
j
?
ð3Þ
The generalised formula is invariant to the order of variables appearing in the VAR,
and is equal to the orthogonal version when the covariance matrix is diagonal. The
generalised formula provides results that are not conditioned on ordering of variables.
SRI markets
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A number of diagnostic tests are conducted before performing the VAR analysis.
In order to determine the stationarity of the data, unit root tests based on the Augmented
Dickey-Fuller (ADF) and Phillips-Peron (PP) tests are performed ?rst. The optimal lags
to be used in the model are also tested ?rst based on the Schwartz information criterion.
As these tests are already well-known in the literature, discussions of these tests are
no longer provided.
This study investigates international integration among SRI markets of Australia,
Canada, Japan, the UK, and the USA. These are the world’s leading and fast growing
SRI markets (DJSI, 2007; Gardner, 2007). Data from DJSI are collected via DataStream.
The DJSI derives its investment universe from the Dow Jones total stock market
index-World with both indices employing the same methodology for calculating,
reviewing, and publishing their indices. The full integration of the two indices enables
a direct comparison of each index’s characteristics, whilst allowing for a direct
comparison of their relative risks and performance.
The DJSI employs the best of sector approach in screening companies. Its primary
source of information comes froma company questionnaire with over 70 multiple-choice
questions focusing on the economic, environmental, and social dimensions with equal
weighting in each of those dimensions. A senior member of the management from each
DJSI rated company is then required to sign off on each questionnaire as a means of
ensuring its accountability and accuracy. The remainder of the ratings information is
subsequently sourced fromeither the speci?c request for company documentation or by
direct dialogue between the analyst and company and ?nally through media and
internet research. Amajor strength of DJSI is that it is one of the only SRI indices that is
fully and regularly audited and veri?ed by independent auditors (Beloe et al., 2004).
The sample period for the study is from January 1994 to May 2010. We allow for
structural breaks in the data pertaining to September 11, 2001 and the global ?nancial
crisis. Hence, the sample period is divided into three sub-periods:
(1) pre-September 11 sub-period, from January 3, 1994 to September 6, 2001;
(2) post-September 11 sub-period, from September 18, 2001 to July 31, 2008; and
(3) the global ?nancial crisis sub-period, from August 1, 2008 to May 31, 2010.
This study utilises daily data. All SRI indices are expressed in US dollars, as stated
earlier, and the data used are in the form of returns on the price indices calculated by
the formula: R
t
¼ ln(price
t
/price
t-1
) £ 100[3].
Figure 1 shows the movement of the SRI indices. The Canadian SRI index peaked
in 2000 and fell dramatically in 2001, which can be explained by the September 11,
2001 attack. Similar behaviour seems to be observed in the USA and Japan markets.
On the other hand, the Australian and UK markets exhibited sustained growth over
the years.
4. Empirical results
4.1 Data preliminaries
Table I shows that the meanreturns were highest duringSub-period2 (post-September 11)
for Australia and Japan whereas for the other SRI markets – Canada, the UK, and the
USA, it was during Sub-period 1 (pre-September 11). All markets experienced the lowest
average returns during the GFC period. However, it is noticeable that Australia and
Canada continued to have positive returns while the other markets had negative returns.
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Figure 1.
Movement of SRI market
indices from 1994 to 2010
Australia
Canada
USA
UK
Japan
800
700
600
500
400
300
200
100
0
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
USA UK Japan Canada Australia
2008 2009 2010
Australia Canada Japan UK USA
Sub-period 1 (pre-September 11): 1994-2001
Mean 0.0002 0.0021 0.0016 0.0092 0.0236
SD 0.0291 0.1075 0.2395 0.2814 0.6245
Skewness 0.1789 20.8560 0.4350 0.0717 20.2760
Kurtosis 4.6501 22.8278 8.8086 4.5057 7.7047
Jarque-Bera 238.16
*
33,088.59
*
2,881.91
*
191.13
*
1,874.55
*
ADF 240.3539
*
232.8912
*
244.5643
*
232.9433
*
244.7176
*
PP 240.1960
*
241.5231
*
244.6646
*
244.2206
*
244.9520
*
Sub-period 2 (post-September 11): 2001-2008
Mean 0.0026 0.0018 0.0025 0.0073 0.0042
SD 0.0655 0.0349 0.1449 0.4094 0.5311
Skewness 20.3691 20.3572 20.1719 20.1648 0.1533
Kurtosis 11.0685 6.3999 4.6505 6.1960 6.2697
Jarque-Bera 4,904.29
*
901.71
*
212.35
*
771.20
*
805.71
*
ADF 242.2571
*
243.3613
*
245.2856
*
227.8499
*
244.7129
*
PP 242.5812
*
243.3501
*
245.6956
*
247.6923
*
244.9451
*
Sub-period 3 (GFC): 2008-2010
Mean 0.0014 0.0013 20.0045 20.0242 20.0125
SD 0.2093 0.1247 0.2550 0.8895 0.8799
Skewness 20.3759 20.3760 0.1181 0.0860 20.1290
Kurtosis 4.4917 6.4028 6.6761 7.9078 7.1633
Jarque-Bera 55.81
*
242.89
*
271.39
*
482.33
*
348.00
*
ADF 221.7493
*
217.9353
*
224.5177
*
222.1302
*
224.8554
*
PP 221.7493
*
221.6075
*
224.7040
*
222.3034
*
225.0261
*
Note: Signi?cant at:
*
5 per cent
Table I.
Descriptive statistics
SRI markets
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Thus, it appears that Australia and Canada were the only SRI markets that weathered the
GFC and were therefore the best performers during this sub-period.
The table also points to a presence of non-normalities in the distributions of the
variables. In general, the skewness of the return series indicates distributions around
the means, but with fat tails in several cases. The resulting Jacque-Bera statistics
signify that the normality distribution assumption is not ful?lled. However, the ADF
and PP tests consistently reject the null hypothesis (i.e. H
0
: g ¼ 0) that the series has a
unit root and thereby con?rm that all return series are stationary.
4.2 Preliminary analysis based on correlations
We conduct a preliminary analysis of the extent of integration between the SRI markets
based on correlations. As can be seen in Table II, the overall correlations between the SRI
markets increased over the years from0.16 in Sub-period 1 to 0.27 in Sub-period 2 and to
0.29 in Sub-period 3. However, these correlations remain relatively low – below 0.30.
This indicates that there is a low level of integration among SRI markets although this
linkage is increasing over the years. This, therefore, implies that there is a signi?cant
scope for international diversi?cation across SRI markets worldwide. This also seems to
con?rm the suspicion that the globalisation of SRI markets is beginning to increase the
linkages between them.
Table II further shows that Japan has the lowest correlation with other markets.
During the ?rst sub-period, the USA was the market most linked to other markets
(highest correlation) but in the second sub-period, the other markets, except Japan,
Australia Canada Japan The UK The USA All markets
Sub-period 1 (pre-September 11): 1994-2001
Australia 1 0.1189
Canada 0.0890
* *
1 0.1916
Japan 0.1785
* *
0.0483
*
1 0.1010
The UK 0.1567
* *
0.1716
* *
0.1323
* *
1 0.1827
The USA 0.0511
*
0.4577
* *
0.0435 0.2707
* *
1 0.2051
Average correlation 0.1189 0.1916 0.1010 0.1827 0.2051 0.1599
Sub-period 2 (post-September 11): 2001-2008
Australia 1 0.2746
Canada 0.2628
* *
1 0.3236
Japan 0.4912
* *
0.1304
* *
1 0.2106
The UK 0.3161
* *
0.4683
* *
0.1732
* *
1 0.3382
The USA 0.0283 0.4331
* *
0.0478
*
0.3953
* *
1 0.2261
Average correlation 0.2746 0.3236 0.2106 0.3382 0.2261 0.2747
Sub-period 3 (GFC): 2008-2010
Australia 1 0.4927
Canada 0.4747
* *
1 0.5296
Japan 0.6025
* *
0.2457
* *
1 0.2906
The UK 0.6344
* *
0.6919
* *
0.2825
* *
1 0.5440
The USA 0.2592
* *
0.7061
* *
0.0315 0.5670
* *
1 0.3910
Average correlation 0.4927 0.5296 0.2906 0.5440 0.3910 0.2947
Overall average correlation 0.2954 0.3483 0.2007 0.3550 0.2741 0.2947
Note: Signi?cance at:
*
5 and
* *
1 per cent
Table II.
Correlation analysis
between SRI markets
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overtook it. The UK and Canada are the markets which are most correlated with other
markets. The highest correlations occurred between the following markets: the USA vs
Canada, UK vs Canada, Australia vs Japan, Australia vs UK, and the USA vs UK while
the lowest correlation was between Japan vs UK.
The results of the correlation analysis therefore indicate that the SRI markets are
becoming more linked or integrated over the years. We consider this observation in the
context of the relationship between stock markets since SRI markets are a part of stock
markets. In this regard, we present the correlations between the stock markets of the
Australia, Canada, Japan, UK, and the USA in Table III. It can be clearly seen from
Table III that the correlations between stock markets increased over the years. However,
the increase in correlations between SRI markets (shown in Table II) is much higher than
the increase in correlations between national equity markets. Hence, the increasing
linkages between SRI markets could not be solely due to the increasing integration
between stock markets and therefore is worthy of a separate investigation. As discussed
previously, SRI as a form of investment signi?cantly differs from conventional
investment and therefore needs to be examined separately.
In light of these circumstances, we therefore conduct a further analysis of the
relationship among the SRI markets based on methodologies that are more robust than
correlation. It is already well-known in the literature that correlations suffer from a
number of weaknesses including the assumption of linearity. We apply VAR, VDC, and
impulse response analyses as these are known to overcome problems of misspeci?cation
and also allow for a simultaneous multi-variable analysis.
Australia Canada Japan The UK The USA All markets
Sub-period 1 (pre-September 11): 1994-2001
Australia 1 0.3877
Canada 0.2264
* *
1 0.4751
Japan 0.3187
* *
0.1172
* *
1 0.3441
The UK 0.3127
* *
0.3415
* *
0.2540
* *
1 0.4428
The USA 0.0808
* *
0.6906
* *
0.0305 0.3059
* *
1 0.4216
Average correlation 0.3877 0.4751 0.3441 0.4428 0.4216 0.4143
Sub-period 2 (post-September 11): 2001-2008
Australia 1 0.4800
Canada 0.3845
* *
1 0.5446
Japan 0.5080
* *
0.1941
* *
1 0.3915
The UK 0.4200
* *
0.5456
* *
0.2098
* *
1 0.5153
The USA 0.0875
* *
0.5986
* *
0.0453 0.4010
* *
1 0.4265
Average correlation 0.4800 0.5446 0.3915 0.5153 0.4265 0.4716
Sub-period 3 (GFC): 2008-2010
Australia 1 0.6217
Canada 0.5441
* *
1 0.6549
Japan 0.5864
* *
0.2483
* *
1 0.4192
The UK 0.7040
* *
0.7363
* *
0.2798
* *
1 0.6579
The USA 0.2741
* *
0.7455
* *
-0.0185 0.5694
* *
1 0.5141
Average correlation 0.6217 0.6549 0.4192 0.6579 0.5141 0.5736
Overall average correlation 0.4965 0.5582 0.3849 0.5387 0.4540 0.4865
Note: Signi?cance at:
*
5 and
* *
1 per cent
Table III.
Correlation
analysis between
national equity markets
SRI markets
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Before estimating the VAR, we ?rst determine the optimum lag to be used. Test results
for the optimum lags are presented in Table IV. The results show that a lag of 1 was
signi?cant in both periods. Hence, a VAR with lag order of 1 is estimated.
4.3 Signi?cant market linkages
We ?rst perform the VAR analysis to determine which markets are signi?cantly linked.
In performing this analysis, we control for the effect of the size of each market. The VAR
is estimated based on the weighted returns of each market where the weight is the
proportion of the capitalisation of each market in relation to the total capitalisation of the
?ve markets derived from DJSI. The results from the VAR analysis are presented in
Table V. It can be seen from the table that all markets have a signi?cant coef?cient –
either as a market in?uencing another market or as a market that is being in?uenced.
Thus, there is signi?cant interdependence among all markets which supports the
?ndings fromthe correlation analysis. We, therefore, investigate the degree and manner
of interaction among the markets that are signi?cantly linked in the next two sections
based on the VDC and impulse response analysis.
4.4 Degree of interdependence between SRI markets
Since all markets are signi?cantly linked, we therefore estimate the magnitude of the
linkage of each market. This is done through the VDC. The results show the percentage
of the forecast variance of each market, listed in the different rows, which are accounted
for by each market listed in the different columns of the table. The number in the
diagonal line represents the percentage of the forecast variance that is due to itself while
the rest of the numbers in each row would represent the effect of other markets, on a
particular market, which are totalled in the last column. The total effect of each market
on other markets is given by each number shown in the row titled “effect on other
markets”. Thus, the outputs of the VDC indicate the impact of each market on other
markets, as well as the extent by which each market is in?uenced by other markets.
From the results of the VDC, we can identify which markets are most (less) in?uential
and more (less) open. We can also infer fromthe VDC results the extent of openness of all
the markets.
The results of the VDC analysis, which is reported in Table VI, also con?rm the
results from the correlation analysis – that is, that the SRI markets have become more
integrated over the years. As can be seen in Table VI, in the last column, the SRI markets
have become more affected by other markets (from 47.3 in Sub-period 1 to 122.3 in
Sub-period 2 to 239.8 in Sub-period 3). During the pre-crisis sub-period (Sub-period 1),
it was only the USA that was most open with 25.7 per cent of its forecast variance being
driven by other markets. This is a re?ection of the early development of the SRI market
Lags
Periods 0 1 2 3
Sub-period 1 (pre-September 11): 1994-2001 24.0459 24.1003
a
24.0356 23.9626
Sub-period 2 (post September 11): 2001-2008 25.8451 26.2732
a
26.2077 26.1469
Sub-period 3 (GFC): 2008-2010 1.3116 0.4750
a
0.5436 0.7517
Note:
a
Lowest Schwarz information criterion
Table IV.
Optimum lag test results
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Table V.
VAR output
SRI markets
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and its globalisation. However, in the second sub-period, in addition to the USA, the UK,
and Japanese markets also became highly open markets. For each of these three markets,
around 30 per cent of their forecast variances were due to other markets. Finally, in the
third sub-period, these three markets continued to be the most open markets and in fact,
became more open with 66.2 per cent of the UK’s, 61.3 per cent of the USA’s, and
48.7 per cent of Japan’s forecast variance being accounted for by other markets. The
GFC, therefore, resulted in these SRI markets being more affected by other markets.
Again, this could be due to the USA, UK, and Japanese companies being cross-listed in
foreign markets which make themvulnerable to the conditions of those foreign markets,
such as Canada and Australia.
The market with the most impact on other markets is Canada that accounted, on
the average, for a total of 63.1 per cent of the forecast variance of all other markets. The
second most in?uential market is Australia as this accounted for 41.4 per cent of the
forecast variance of all other markets. Japan, on the other hand, had the lowest overall
effect on other markets, accounting for less than 1 per cent of the forecast variance. The
Canadian market mainly drives the USA and UK markets while the Australian market
in?uences greatly the UK, Canadian and Japanese markets. Again, the Canadian SRI
market, while not as large as the USA, is also relatively signi?cant and has grown
substantially over the years. The Australian market, while much smaller than that of
Canada, has been the fastest growing market over the years. Again, most US companies
that are considered to be sustainable are also heavily involved in the Canadian and
Australian market and therefore developments in these two markets will also affect
Independent variable
Dependent variable Australia Canada Japan
The
UK
The
USA
Total effect of
other markets
Sub-period 1 (pre-September 11): 1994-2001
Australia 95.2306 1.6985 0.0426 1.7337 1.2947 4.7694
Canada 0.4714 98.8376 0.1655 0.2048 0.3206 1.1624
Japan 1.8028 2.6263 92.7391 2.0288 0.8030 7.2609
The UK 1.6502 2.5085 0.7664 91.5428 3.5321 8.4572
The USA 0.2230 20.9124 0.0651 4.4753 74.3241 25.6759
Total effect on other markets 4.1475 27.7457 1.0396 8.4426 5.9504 47.3339
Sub-period 2 (post September 11): 2001-2008
Australia 78.1845 16.8406 0.1076 2.4988 2.3685 21.81549
Canada 8.8238 90.2922 0.0680 0.0166 0.7994 9.707832
Japan 12.4483 8.6842 70.3244 4.2404 4.3028 29.67563
The UK 8.2364 15.1424 0.0301 67.0471 9.5440 32.95294
The USA 0.4054 19.6337 0.3403 7.7734 71.8472 28.15281
Total effect on other markets 29.9139 60.3009 0.5460 14.5292 17.0146 122.3047
Sub-period 3 (GFC): 2008-2010
Australia 65.2389 22.3030 0.2566 2.3010 9.9006 34.76114
Canada 23.2848 71.1114 0.1340 2.0819 3.3879 28.88856
Japan 17.9468 16.8571 51.3441 8.0625 5.7896 48.65589
The UK 30.2052 24.3768 0.2590 33.8142 11.3449 66.18584
The USA 18.5859 37.8321 0.6665 4.2438 38.6717 61.32832
Total effect on other markets 90.0226 101.3690 1.3161 16.6892 30.4229 239.8198
Overall period average effect
on other markets 41.3757 63.1377 0.9738 13.1765 17.7899 136.4536
Table VI.
VDC analysis result
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the US market. The study by Huyghebaert and Wang (2010) in relation to the integration
of stock markets has also con?rmed this phenomenon. They found that Hong Kong and
Singapore drive the US market.
In summary, the forecast VDC analysis results indicate that the markets became
more interdependent over the years. Canada and Australia are the most in?uential SRI
markets while Japan is the least in?uential. Further, the USA is the most open and
interdependent market while Canada is the least.
4.5 Duration and speed of interaction between SRI markets
In the last part of our examination of the integration between SRI markets worldwide,
we investigate the manner of interaction between the markets which are signi?cantly
linked. We analyse the speed and duration of the co-movement between the markets.
The shorter (longer) and the faster (slower) the interaction is, the more (less) integrated
the markets are. As discussed in the methodology section of the paper, this is done
based on the impulse response analysis within the context of the VAR system. Impulse
responses provide evidence on how much and how quick the movement of one market
is transmitted to the others.
The impulse responses of each SRI market to the price movements from other
markets are shown in Figure 2. An inspection of Figure 2 reveals that all responses were
immediate in all the three sub-periods – that is, each market immediately responded to
news from other markets during the ?rst day. The responses are completed within a
period of two-three days – that is, each market is able to ?nish its reaction to other
markets within this time period. In the international ?nance literature, this duration of
response is considered to be ef?cient. We, therefore, interpret this as further evidence
that SRI markets are quite signi?cantly linked or integrated.
The sensitivity to external shocks varies signi?cantly among the markets. The USA
and the UK are the most responsive markets while Australia and Canada are the least
open markets. The UK and the USA have also become more responsive over the years
particularly during the GFC sub-period. Again, this implies that these two markets are
becoming more integrated with other markets. As also shown in Figure 2, the USA and
the UKhave even become more sensitive to other markets during the GFC sub-period –
meaning, they have been more affected by events in other markets during this
sub-period. Once again, this could be because of the heavy presence of their companies
overseas.
In summary, therefore, the impulse response analysis results also point to an
increasing integration among the SRI markets over the years.
5. Conclusion
This study investigates the international integration of SRI markets through an
examination of the extent, speed, and duration of price interaction between the markets
of Australia, Canada, Japan, the UK, and the USA using daily DJSI data covering the
period 1994-2007. The period is divided into three sub-periods to allow for the
structural break arising from the events of September 11th and the global ?nancial
crisis. The study employs VDC and impulse response analysis based on the VAR
context. A preliminary analysis is also conducted based on correlations.
The results show that all SRI markets signi?cantly affect each other. The markets
respond to each other quite rapidly and within a short period of time. Furthermore,
SRI markets
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the linkage between the SRI markets increased over the years, particularly during the
GFC period. These results indicate that the markets are becoming more signi?cantly
integrated over the years; however, this integration is still at a low level. This implies,
therefore, that there is still very signi?cant scope for SRI investors to diversify
internationally across SRI markets.
Figure 2.
Impulse responses
for the SRI markets
USA
Period 1 (Pre-
september 11):
1994-2001
UK
Period 1 (Pre-
september 11):
1994-2001
Japan
period 1 (Pre-
september 11):
1994-2001
Canada
period 1 (Pre-
september 11):
1994-2001
Australia
period 1 (Pre-
september 11):
1994-2001
USA
Period 2 (Post
september 11):
2001-2008
UK
Period 2 (Post
september 11):
2001-2008
Japan
period 2 (Post
september 11):
2001-2008
Canada
period 2 (Post
september 11):
2001-2008
Australia
period 2 (Post
september 11):
2001-2008
USA
Period 3 (GFC):
2008-2010
UK
Period 3 (GFC):
2008-2010
Japan
period 3 (GFC):
2008-2010
Canada
period 3 (GFC):
2008-2010
Australia
period 3 (GFC):
2008-2010
Australia Canada Japan UK USA
1.00
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In terms of speci?c markets, the study found that the USA and the UK are the most
signi?cantly open and interlinked markets which re?ect the high globalisation of these
markets. These markets are heavily in?uenced by movements in prices in the other SRI
markets. This had become particularly so during the GFC period. On the other hand,
Australia and Canada seems to be more driven by events in their own markets rather
than by those in other markets. Thus, from the point of view of portfolio
diversi?cation, it appears that Australia and Canada can provide better bene?ts as
compared to the USA and the UK, as the former two markets enjoy lower correlations
with other markets while the latter have higher correlations.
In conclusion, the results of the study indicate that SRI markets are interdependent
and integrated and become more so over the years. However, since the level of
integration among the markets is still relatively low, SRI investors and trustees may be
heartened that there are still bene?ts to be gained by internationally diversifying across
SRI markets worldwide. This would, therefore, allowthemto alleviate to a certain extent
the limitation on diversi?cation that they suffer in their involvement in SRI. These
results should also be of concern to ?nancial regulators. Since SRI markets have been
found to be signi?cantly integrated, there is the risk of contagion among markets. This
would, therefore, require a coordination of policies across SRI markets worldwide if
contagion risk is to be contained or eliminated.
Notes
1. SRI assets were worth US $2.71 trillion in the USA, as reported by the Social Investment
Forum: United States (2007), and C$503 billion (US $471 billion) in Canada based on
information from the Canadian Social Investment Organization (2006). In Europe, the UK is
the leading SRI market with assets valued at e781 billion (US $1.17 trillion) based on data
from the European Social Investment Forum (2006). In Asia, the leading SRI market is Japan
with up to ¥840 billion (US $7.3 billion) worth of SRI assets (SIF-J, 2007). Finally, Australia is
the fastest growing SRI market, with total assets of A $19.4 billion (US $17.3 billion) as
reported by the Responsible Investment Association Australasia (2007).
2. As argued by Kenen (1976):
[. . .] integration refers to the degree to which participants in any market are enabled and
obliged to take notice of events occurring in other markets. They are enabled to do so when
information about those events is supplied into the decision making processes of recipients.
They are obliged to do so when it is supplied in ways that invite them to use it in order to
achieve their own objectives [. . .]
This de?nition, therefore, implies information spill-over.
3. The continuous return formula is used as it is well-known to provide more accurate measure
of return compared to the discrete formula (Brailsford et al., 2004, p. 9).
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About the authors
Eduardo Roca is an Associate Professor at the Department of Accounting, Finance and
Economics, Grif?th Business School, Grif?th University, Queensland, Australia. Eduardo Roca
is the corresponding author and can be contacted at: e.roca@grif?th.edu.au
Victor S.H. Wong is a Lecturer at the Department of Accounting, Finance and Economics,
Grif?th Business School, Grif?th University, Queensland, Australia.
Gurudeo Anand Tularam is a Lecturer at the Faculty of Science, Engineering, Environment
and Technology, Grif?th University, Queensland, Australia.
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