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Which way does water flow? An econometric analysis of the global price integration of water stocks

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Around US$600 billion of investment is desperately needed to address forecasted huge shortages in water supply globally. A number of worldwide investors – so-called water funds – have started to take up this challenge. For these global water investors, knowledge about the extent of integration between the water sectors of financial markets is highly important. According to international portfolio diversification theory, the less (more) integrated markets are, the more (less) benefits there are from international diversification. In this study, we investigate the extent and manner of interdependence among the US, European and Asian water sector of the equity markets based on Vector Autoregression (VAR), Granger causality and impulse response analyses. We find that world water stock market prices are indeed significantly interdependent although this interdependence varies across time periods. Each market quickly responds to shocks from each other and completes its response within 3 days. Hence, for water investors, international diversification that is undertaken just within the water sector will not be beneficial. The result also implies that there is the risk of crossmarket contagion – that is, price volatility spill over across water sectors of different financial markets, and therefore, water authorities in one market should take cognisance of events in other markets.
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Keywords: C32; G15; Q25; environmental finance; financial market integration; impulse response; variance decomposition; vector autoregression; water finance

Document Type: Research Article

Affiliations: 1: Department of Accounting, Finance and Economics,Griffith Business School, Griffith University, NathanQLD 4111, Australia 2: Faculty of Science,Engineering, Environment and Technology, Griffith University, NathanQLD 4111, Australia

Publication date: 2012-08-01

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