Eur. Phys. J. B 72, 657-669 (2009)
https://doi.org/10.1140/epjb/e2009-00384-y

The Index cohesive effect on stock market correlations

School of Physics and Astronomy, The Raymond and Beverly Sackler Faculty of Exact Sciences, Tel-Aviv University, Tel-Aviv, 69978, Israel

Corresponding author: ^a eshelbj@gmail.com

Received: 21 January 2009
Revised: 15 April 2009
Published online: 10 November 2009

Abstract

We present empirical examination and reassessment of the functional role of the market Index, using datasets of stock returns for eight years, by analyzing and comparing the results for two very different markets: 1) the New York Stock Exchange (NYSE), representing a large, mature market, and 2) the Tel Aviv Stock Exchange (TASE), representing a small, young market. Our method includes special collective (holographic) analysis of stock-Index correlations, of nested stock correlations (including the Index as an additional ghost stock) and of bare stock correlations (after subtraction of the Index return from the stocks returns). Our findings verify and strongly substantiate the assumed functional role of the index in the financial system as a cohesive force between stocks, i.e., the correlations between stocks are largely due to the strong correlation between each stock and the Index (the adhesive effect), rather than inter-stock dependencies. The Index adhesive and cohesive effects on the market correlations in the two markets are presented and compared in a reduced 3-D principal component space of the correlation matrices (holographic presentation). The results provide new insights into the interplay between an index and its constituent stocks in TASE-like versus NYSE-like markets.