THE INTEGRATION AND EFFICIENCY OF INTERNATIONAL BOND MARKETS

The benefits of international portfolio diversification are usually presented as movements towards the mean-variance efficient frontier, being constructed from historical correlation and return data. An alternative approach involves the use of a recent econometric advance known as cointegration. A study uses the Engle and Granger cointegration 2-step methodology to examine the degree of integration of the US, the UK, West German, and Japanese government bond markets, using the Salomon Brothers total return indices for the period 1978-1990. Using sterling adjusted returns, the study finds that the markets were not well integrated over the sample period (in contrast to findings for international equity markets). These results suggest that diversification between these markets might bring considerable benefits for the sterling investor since country specific factors dominate these markets.