Financial Integration and Comovements Between Capital Markets and Oil Markets: An Approach During the Russian Invasion of Ukraine in 2022

Introduction

The international financial markets have seen a succession of major setbacks triggered by the Covid-19 pandemic, followed by a series of collapses, the oil war, and currency fluctuations. The economic turmoil associated with the coronavirus pandemic in 2019-2020 had severe repercussions on the financial markets, notably the stock, bond, and commodity markets (including crude oil and gold). The main events were an oil price war between Russia and Saudi Arabia after an Organization of the Petroleum Exporting Countries (OPEC) agreement was not reached, leading to the collapse of oil prices, and a significant drop in stock markets in March 2020 (Sudha and Sornaganesh, 2020).

The 2020 epidemic has negatively affected global trade, as well as, social and cultural life, including tourism, commodity trade, manufacturing, and sectors such as transportation. Thus, rating agencies such as Moody's and Standard & Poors have reduced China's growth forecast for 2020. In line with all these negative effects, it seems inevitable that stock markets, economic growth and exchange rates have also been affected equally (Liu, Manzoor, Wang, Zhang, and Manzoor, 2020).

On February 21, 2022, Putin recognized the Donetsk People's Republic and the Lugansk People's Republic, two self-proclaimed regions as states, controlled by pro-Russian separatists in Donbas. The next day, the Russian Federation Council unanimously authorized the use of military force and Russian troops entered both territories. On February 24, Putin announced a “special military operation,” supposedly to “demilitarize” and “denazify” Ukraine. Minutes later, missiles struck sites across Ukrainian territory, including Kiev, the capital. The Ukrainian Border Guard reported attacks on border crossings with Russia and Belarus. Soon after, Russian ground forces entered Ukraine (Bloomberg, 2022).

In the context of financial market integration, investors generally seek to include assets in their portfolios that hold lower levels of correlation to promote effective diversification strategies. In the same context, Grubel (1968), Levy and Sarnat (1970) argue that investing in international markets is substantiated by the fact that the correlation between assets is lower than that examined in domestic assets. Therefore, the low correlation between international stock markets is a key factor for portfolio diversification.

Financial instability is a very important factor for society, since a financial crisis or a stock market crash can affect, directly or indirectly, the level of economic well-being of a country's inhabitants. If a given financial market is strongly linked to the financial market of another country, the financial stability of the former depends in part on the financial stability of the latter. For this reason, a close or strong link between markets increases the levels of vulnerability to external shocks and, as a result, influences the economic conditions and welfare levels of the respective countries. Thus, the occurrence of integration between markets can have significant implications for international risk diversification (Dias et al., 2019, 2020; Pardal, P., Dias, R., Šuleř, P., Teixeira, N., and Krulický, 2020; Dias, Heliodoro, et al., 2021; Dias, Santos, et al., 2021; Dias et al., 2021; Dias and Carvalho, 2021; Pardal et al., 2021).