Stock Returns in Transition and Developed Economies During the 2007-09 Financial Crisis

The 1980s have brought about massive economic and political changes that affected the lives of millions of people worldwide.  Perestroika (restructuring) and glasnost (openness) introduced by Mikhail Gorbachev in the USSR, Solidarity movement in Poland, the unification of GDR with FRG in 1989, and the final disintegration of the USSR in 1991 have given world development a new impetus.  Moving toward a more democratic society and market-oriented economy first of all entailed decentralization of the decision-making process in all areas, which ultimately altered social, political, and economic relationships, as well as institutional structures.  Over time, the authorities in transition economies have made deliberate attempts to reorganize the financial institutions, liberalize financial markets, and implement laws and regulations that improve transparency and resiliency of the financial systems, thus providing much needed funds for the transforming economies.            Theoretically speaking, financial liberalization and integration can lead to greater economic efficiency and improve economic well-being of the society through creating a net of markets and institutions that are capable of channeling funds from those who have excess to those who have a shortage of funds but know how to use these funds in a productive way.  Such credit expansion to businesses leads to an increase in investment in capital goods and subsequently results in a greater output. However, financial integration also increases correlation between the assets returns, which erodes some of the international diversification potential.            This paper will compare stock returns between transition and advanced economies before and during the 2007-2009 financial crisis.  It will use time series return information from stock indexes in transition economies and developed economies to examine levels of correlation of returns among transition economies and between transition economies and developed economies.  It will also investigate changes in these correlations over time in order to capture the effect of the financial crisis that has originated in the advanced economies.