ESSAYS ON FINANCIAL MARKET LINKAGES IN EAST ASIAN COUNTRIES ZHENG YI A THESIS SUBMITTED FOR THE DEGREE OF DOCTOR OF PHILOSOPHY OF ECONOMICS DEPARTMENT OF ECONOMICS NATIONAL UNIVERSITY OF SINGAPORE 2007 ACKNOWLEDGEMENTS After the accomplishment of this dissertation, my heart is filled with joy as well as indebtednesses. Along my pursuance of Ph.D. study during the past years, lots of helps and encouragements from many sources have been critical in motivating me to forge ahead with this prolonged yet demanding task. First and foremost, I am greatly indebted to my supervisor, Prof. Wong Wing Keung, from whom I have learned research methodologies as well as academic genre; his professional supervision and ceaseless support have been indispensable through the whole process of my thesis writing. Secondly, I am deeply grateful to Prof. Kim Yoonbai and Dr. Heejoon for acting as members of my dissertation committee. I would also like to much thank Prof. Kapur, Basant Kumar, Prof. Abeysinghe, Tilak, Prof Xing Xiaolin, Dr. Gamini Premartne, Dr. Lee Jin and Dr.Lin Mau-Ting for giving me invaluable comments at my pre-submission presentation. The list is incomplete without mentioning Mr. Chen Heng, who guides me in programming and also gives me countless encouragement. I am also deeply indebted to my family and my friends for their love and support. Last but not least, I would like to thank Ms. Nicky and other faculty staff in the Department of Economics, NUS, for their kind help during the course of my study. ii Table of Contents Acknowledgements ii List of Tables v List of Figures vii Abstract viii Chapter1: Stock Market Integration in East Asian Countries: Global or Regional? 1.1 Introduction 1.2 Literature Review 1.3 Methodological Outline 14 1.4 Empirical Results 21 1.5 Conclusion 35 Chapter 2: Financial Integration in East Asia---Evidence from Real Interest Rate Linkage 37 2.1 Introduction 37 2.2 Literature Review 41 2.3 Data and Methodology 44 2.4 Empirical Analysis 57 2.5 Conclusion 73 Chapter 3: Mean and Volatility Spillovers and Time-Varying Conditional Dependence in Chinese Stock Markets 75 3.1 Introduction 75 3.2 Literature Review 81 3.3 Data and Methodology 84 iii 3.4 Empirical Results 93 3.5 Conclusion 106 Chapter 4: Summary 108 Bibliography 114 Appendix A 125 Appendix B 131 Appendix C 132 iv List of Tables Table 1.1: Stock Market Capitalization as percent of GDP Table 1.2: Signals of Stock Market Liberalization in East Asia Table1.3: Basic Statistics of Stock Return Series 22 Table 1.4: Correlations of stock return series: Jan. 1990-Jan. 2006 23 Table 1.5: Correlations of stock return series: Jan. 1990 – Jun. 1997 23 Table 1.6: Correlations of stock return series: Jan. 1999- Jan. 2006 24 Table 1.7: Estimates of model Eq. (1.11) 26 Table 1.8: Average global and regional scores for each country for the whole period 26 Table 1.9: Average global and regional scores before, during and after Financial Crisis 28 Table1.10: Average integration scores before and after Chiang Mai Initiative 30 Table1.11: Maximum integration scores and corresponding date 32 Table1.12: Diagnostics for the residual of entertained model 35 Table 2.1: Summary statistics of real interest rate differentials 60 Table 2.2: Unit root test for real interest rates and their differentials 61 Table 2.3: Cointegration results in East Asia for the whole sample period and subperiods 64 Table 2.4: VECM model results 66 Table 2.5: Variance decomposition of the East Asian countries 69 Table 2.5C: Variance decomposition with the order of Yt = [ R ja , Rus , Ri ] 73 Table 3.1: Descriptive Statistics for the Weekly Stock Index Returns 86 v Table 3.2: Estimated results on Shanghai A share and B share 95 Table 3.3: Diagnostics for the model fitted on Shanghai A and B shares 99 Table 3.4: Estimated results on Shenzhen A share and B share 100 Table 3.5: Diagnostics for the model fitted on Shenzhen A and B shares 103 vi List of Figures Figure 1.1: Time-varying pattern of stock market integration 125 Figure1.2: Time-varying pattern of stock market integration (MSCI country data) 128 Figure 2.1: Plot of real interest rates, East Asian countries against US 58 Figure 2.2: Plot of real interest rates of East Asian countries less US real interest rate, from 1993 to 2004. 59 Figure 3.1: Price indices of Chinese stock market 132 Figure 3.2: Returns of Shanghai A, B shares and Shenzhen A, B shares 133 Figure 3.3: Conditional Correlation of A and B-shares in Shanghai market 134 Figure 3.4: Conditional Standard Deviation of A and B-shares in Shanghai market 135 Figure 3.5: Conditional Correlation of A and B-shares in Shenzhen market 136 Figure 3.6: Conditional Standard Deviation of A and B-shares in Shenzhen market 137 vii Abstract This dissertation studies the financial market linkages in East Asian countries. It is composed of three chapters each of which investigates the financial market linkage in the region of East Asia from different perspectives. The first chapter examines the timevarying integration of stock markets in East Asian region since 1990s. The model applied in this chapter is extended from methodology of Akdogan (1996), which measures integration by the fraction of systematic risk in total country risk relative to global benchmark. By extending his method to two-factor setting with heteroskedasticity structure in the stock returns, it is possible to investigate the evolution of the integration process as well as whether East Asian stock markets become more integrated into the world market or the regional market in the long run. We also examine to what extent the Financial Crisis in 1998 and Chiang Mai Initiative of 2000 have affected the degree of integration among these markets. Overall, our results show that most of the East Asian countries are integrated more into the world market rather than regional market. Since 2000, there is evidence of increasing regional interdependence for most of these countries, and Korea and Taiwan have experienced a distinctly increasing degree of global integration. Financial crisis largely changed the pattern of stock market interdependence in East Asian countries; however, the impact is temporary rather than long-lasting. Furthermore, since Chiang Mai Initiative, which is one of the most important measures to promote financial collaboration, the region has seen an increase in regional integration. The second chapter investigates the degree of financial integration between East Asian countries and US as well as Japan by assessing the co-movements of real interest rates. Granger cointegration test and vector error correction model (VECM) are applied viii to examining long-run relationship as well as short-run dynamics of real interest rates when they deviate from equilibrium. Our results show that despite the failure of real interest rate parity, strong evidence is found in favor of increasing financial integration between East Asia and US if the possible structural break is accounted for. Results from vector error correction model demonstrate that Japan has not taken over the dominant role of US in influencing the East Asian financial markets. The technique of bootstrap is employed to obtain point estimates and measure the corresponding accuracy of estimates in cointegration regressions and VECMs. In addition, we also apply variance decomposition analysis to depicting the evolution of US and Japan’s influences on the region. The results confirm the increasing external influences on East Asian markets and there is evidence that Japan’s influence to East Asia, though limited, is increasing after financial crisis of 1998. Finally, the third chapter inspects in detail one unique and distinguishing market in East Asia, namely Chinese stock market, as China underpinned by its fast-evolving economy is surely going to be a significant player in this region. In particular, we employ a two-stage bivariate GARCH model to study three issues concerning A-share and Bshare in China’s stock market. The first is mean and volatility spillover between return series of A-share and B-share; the second is time-varying conditional correlation between A-share and B-share; and the third one is the impacts of the U.S. and Hong Kong stock markets on the first two moments of China’s two types of shares. Our empirical results show that there does exist time-varying information transmission between A-share and Bshare. However the mean spillover between the two types of shares is scarce, although they are residing in the same economic environment. In Shanghai exchange, B-share is ix more influential than A-share in the interactions of shares; whereas, in the smaller and less liquid Shenzhen market, A-share appears to lead B-share in most of time. We also find that the correlation between A-share and B-share is time-varying and exhibit an upward trend in both exchanges. Lastly, we provide evidence that external effects from the U.S. and Hong Kong spill to China’s stock market, and these effects are also evolving with time. It is found that the Hong Kong market has a larger impact on the China’s A and B-shares than does the U.S. market, suggesting a larger role played by regional rather than global influences on China’s stock trading. 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Donald (1992), Further evidence on the great crash, the oil-Price Shock, and the Unit-Root Hypothesis, Journal of Business and Economics Statistics, 10,3,251-270 125 126 17/01/2004 17/01/2002 17/01/2000 17/01/1998 17/01/1996 17/01/1994 17/01/1992 17/01/2004 17/01/2002 17/01/2000 17/01/1998 17/01/1996 17/01/1994 17/01/1992 17/01/1990 17/01/2004 17/01/2002 17/01/2000 17/01/1998 17/01/1996 17/01/1994 17/01/1992 17/01/1990 17/01/1990 Appendix A Figure 1.1: Time-varying pattern of stock market integration Japan 0.8 0.6 0.4 A(world) 0.2 B(region) Hong Kong 0.8 0.6 0.4 A(world) 0.2 B(region) Singapore 0.8 0.6 0.4 A(world) 0.2 B(region) 127 17/01/2004 17/01/2002 17/01/2000 17/01/1998 17/01/1996 17/01/1994 17/01/1992 17/01/1990 17/01/2004 17/01/2002 17/01/2000 17/01/1998 17/01/1996 17/01/1994 17/01/1992 17/01/1990 17/01/2004 17/01/2002 17/01/2000 17/01/1998 17/01/1996 17/01/1994 17/01/1992 17/01/1990 Korea 0.8 0.6 0.4 A(world) 0.2 B(region) Taiwan 0.8 0.6 0.4 A(world) 0.2 B(region) Malaysia 0.8 0.6 0.4 A(world) 0.2 B(region) 128 16/01/2005 16/01/2004 16/01/2003 16/01/2002 16/01/2001 16/01/2000 16/01/1999 16/01/1998 16/01/1997 16/01/1996 16/01/1995 16/01/1994 16/01/1993 16/01/1992 17/01/2004 17/01/2002 17/01/2000 17/01/1998 17/01/1996 17/01/1994 17/01/1992 17/01/2004 17/01/2002 17/01/2000 17/01/1998 17/01/1996 17/01/1994 17/01/1992 17/01/1990 17/01/1990 17/01/2004 17/01/2002 17/01/2000 17/01/1998 17/01/1996 17/01/1994 17/01/1992 17/01/1990 16/01/1991 Thailand 0.8 0.6 0.4 A(world) 0.2 B(region) Philippine 0.8 0.6 0.4 A(world) 0.2 B(region) Indonesia 0.8 0.6 0.4 A(world) 0.2 B(region) China 0.06 0.05 0.04 0.03 A(world) 0.02 0.01 B(region) 129 17/01/2004 17/01/2002 17/01/2000 17/01/1998 17/01/1996 17/01/1994 17/01/2004 17/01/2002 17/01/2000 17/01/1998 17/01/1996 17/01/1994 17/01/1992 17/01/1990 17/01/2004 17/01/2002 17/01/2000 17/01/1998 17/01/1996 17/01/1994 17/01/1992 17/01/1990 17/01/1992 17/01/1990 Figure 1.2 Time-varying pattern of stock market integration (MSCI country data) Japan 0.8 0.6 0.4 A(world) 0.2 B(region) Hong Kong 0.8 0.6 0.4 A(world) 0.2 B(region) Singapore 0.8 0.6 0.4 A(world) 0.2 B(region) 130 17/01/2004 17/01/2002 17/01/2000 17/01/1998 17/01/1996 17/01/1994 17/01/1992 17/01/2004 17/01/2002 17/01/2000 17/01/1998 17/01/1996 17/01/1994 17/01/1992 17/01/2004 17/01/2002 17/01/2000 17/01/1998 17/01/1996 17/01/1994 17/01/1992 17/01/1990 17/01/1990 17/01/2004 17/01/2002 17/01/2000 17/01/1998 17/01/1996 17/01/1994 17/01/1992 17/01/1990 17/01/1990 Korea 0.8 0.6 0.4 A(world) 0.2 B(region) Taiwan 0.8 0.6 0.4 A(world) 0.2 B(region) Malaysia 0.8 0.6 0.4 A(world) 0.2 B(region) Thailand 0.8 0.6 0.4 A(world) 0.2 B(region) 131 16/01/2005 16/01/2004 16/01/2003 16/01/2002 16/01/2001 16/01/2000 16/01/1999 16/01/1998 16/01/1997 16/01/1996 16/01/1995 16/01/1994 16/01/1993 16/01/1992 17/01/2004 17/01/2002 17/01/2000 17/01/1998 17/01/1996 17/01/1994 17/01/1992 17/01/1990 17/01/2004 17/01/2002 17/01/2000 17/01/1998 17/01/1996 17/01/1994 17/01/1992 17/01/1990 16/01/1991 Philippine 0.8 0.6 0.4 A(world) 0.2 B(region) Indonesia 0.8 0.6 0.4 A(world) 0.2 B(region) China 0.06 0.05 0.04 0.03 A(world) 0.02 0.01 B(region) Appendix B Cointegration results between East Asia and Japan after financial crisis CRADF η2 HK -3.759*** 13.067 Sing -2.799** 6.081 Thai -5.175*** 8.921 Phi -4.275*** 14.092 Ind -3.731*** 9.644 Notes: CRADF are cointegrating regression augmented Dickey-Fuller statistics. The critical values have been adjusted for residual-based cointegration test and the finite sample size. η2 is obtained from the DOLS regression, representing the cointegration vector . **indicates significance at 5% level, *** indicates significance at 1% level 132 Appendix C Figure 3.1: Price indices of Chinese stock market SZA SHA 900 300 800 250 700 600 200 500 150 400 100 300 50 200 100 93 94 95 96 97 98 99 00 01 02 03 04 93 94 95 96 97 SZB 98 99 00 01 02 03 04 00 01 02 03 04 SHB 500 240 400 200 160 300 120 200 80 100 40 93 94 95 96 97 98 99 00 01 02 03 04 93 94 95 96 97 98 99 Notes: SHA denotes A share of Shanghai market; SHB denotes B share in Shanghai market; SZA denotes A share of Shenzhen market; SZB denotes B share in Shenzhen market. 133 Figure 3.2: Returns of Shanghai A, B shares and Shenzhen A, B shares .5 .4 .3 .2 .1 .0 -.1 -.2 -.3 -.4 93 94 95 96 97 98 99 00 01 02 03 04 01 02 03 04 01 02 03 04 RSHA .3 .2 .1 .0 -.1 -.2 -.3 93 94 95 96 97 98 99 00 RSHB .4 .3 .2 .1 .0 -.1 -.2 -.3 -.4 -.5 93 94 95 96 97 98 99 00 RSZA .4 .3 .2 .1 .0 -.1 -.2 -.3 -.4 93 94 95 96 97 98 99 00 RSZB 134 01 02 03 04 Figure 3.3: Conditional Correlation of A and B-shares in Shanghai market -0.1 0.3 Coditional correlation between Shanghai A and B shares from 1992 to 1995 Q4 Q1 1992 Q2 Q3 1993 Q4 Q1 Q2 Q3 1994 Q4 Q1 Q2 Q3 1995 Q4 Q1 1996 0.0 0.4 0.8 Coditional correlation between Shanghai A and B shares from 1996 to Feb. 21, 2001 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1996 1997 1998 1999 2000 2001 0.0 0.4 0.8 Coditional correlation between Shanghai A and B shares from Feb.28, 2001 to May, 2005 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 2001 2002 2003 2004 2005 135 Figure3. 4: Conditional Standard Deviation of A and B-shares in Shanghai market Conditional Standard Deviation of Shanghai A and B shares from 1992 to 1995 0.04 0.12 sha.std shb.std Q4 Q1 1992 Q2 Q3 1993 Q4 Q1 Q2 Q3 1994 Q4 Q1 Q2 Q3 1995 Q4 Q1 1996 Conditional Standard Deviation of Shanghai A and B shares from 1996 to Feb.21,2001 0.04 0.12 sha.std shb.std Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1996 1997 1998 1999 2000 2001 0.11 Conditional Standard Deviation of Shanghai A and B shares from Feb.28,2001 to May,2005 0.03 0.07 sha.std shb.std Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 2001 2002 2003 2004 2005 136 Figure 3.5: Conditional Correlation of A and B-shares in Shenzhen market -0.1 0.3 0.7 Coditional correlation between Shenzhen A and B shares from 1992 to 1995 Q4 Q1 1992 Q2 Q3 1993 Q4 Q1 Q2 Q3 1994 Q4 Q1 Q2 Q3 1995 Q4 Q1 1996 0.0 0.4 0.8 Coditional correlation between Shenzhen A and B shares from 1996 to Feb.21,2001 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1996 1997 1998 1999 2000 2001 0.0 0.4 0.8 Coditional correlation between Shenzhen A and B shares from Feb.28,2001 to May,2005 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 2001 2002 2003 2004 2005 137 Figure 3.6: Conditional Standard Deviation of A and B-shares in Shenzhen market 0.12 Conditional Standard Deviation of Shenzhen A and B shares from 1992 to 1995 0.04 sza.std szb.std Q4 Q1 1992 Q2 Q3 1993 Q4 Q1 Q2 Q3 1994 Q4 Q1 Q2 Q3 1995 Q4 Q1 1996 Conditional Standard Deviation of Shenzhen A and B shares from 1996 to Feb.21,2001 0.04 0.12 sza.std szb.std Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1996 1997 1998 1999 2000 2001 0.060 Conditional Standard Deviation of Shenzhen A and B shares from Feb.28,2001 to May,2005 0.030 sza.std szb.std Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 2001 2002 2003 2004 2005 138 [...]... Stock Market Integration in East Asian Countries: Global or Regional? 1.1 Introduction One of the important ways of measuring financial integration is to observe the degree to which the stock markets are interrelated In line with the deepening globalization of financial markets and increasing capital flows across national boundaries, stock markets have become an increasingly important source of financing... China introduced the Qualified Foreign Institutional Investor program as a provision for foreign capital to access China’s financial market, including stock market and bond market With the relaxation of capital control in East Asian countries, the degree of stock market integration and interdependence has become more intensively concerned to international investors, economists and policy makers For international... financial markets from early 1990s The continuous financial opening process has rendered the economies of the region to become much integrated into the global economy However, it is still not clear that the international financial liberalization process has contributed to the integration of financial markets within the East Asian region In general, trade liberalization tends to bring about trade integration... equity market performance in the Far East The countries included are China, Hong Kong, Japan, Indonesia, Korea, Malaysia, Philippines, Singapore Free, Taiwan and Thailand 8 1.2 Literature Review There have been a number of studies examining the interrelation and interaction among the stock market integration in East Asia In general, these papers look at how movements in the stock market in one country interact... external events on stock market integration in the region of East Asia The significant events within our sample period of particular interest to us are East Asian financial crisis in 1997 and Chiang Mai Initiative proposed in 2000 as to promote regional cooperation It is said that Financial Crisis in East Asia has brought about an increase in the cross -market correlation among 5 East Asian stocks This... their intention to cooperate in four principal areas, namely monitoring capital flows, regional surveillance, network swapping and personnel training Although the Chiang Mai Initiative aims at expansion of swap arrangement among East Asian countries and it is more targeting on money markets arrangement among these countries, it could help to build a more stable financial investment environment for international... develop a theoretical indication to measure the time-varying integration among national 4 stock markets Secondly, we empirically estimate the degree of integration between East Asian stock markets and the world market and between each of these markets and the regional market of East Asia as a whole The countries examined are ten countries of East Asia including Japan, Hong Kong, Singapore, Korea, Taiwan,... integrated into the world market rather than the regional market Financial crisis largely changed the pattern of stock market interdependence in East Asian countries with regional integration increasing sharply during the financial crisis period; however the impact is temporary rather than long-lasting Further, our evidences do support the fact that East Asian countries get more regionally integrated... events change the pattern of stock market integration within this region and what the magnitude of their influences is A number of studies have examined the impact of financial crisis on international markets linkages, for example Wing (2003), Hsiao and Tu(2000) Their results generally show financial crisis does influence the degree of financial integration in East Asian markets, however, they were not... East Asia4 In addition, MSCI AC Far East Index includes exactly ten countries examined in this chapter; therefore, the regional score based on this index could provide an accurate picture of how these countries are integrated among themselves Fourthly, the study in this chapter highlights dynamic nature of stock market integration We obtain dynamic integration scorers based on time-varying conditional . stock market linkage in East Asia remains low; and unlike trade integration, the integration of financial markets in this region has been occurring more on a global level rather than on a regional. global economy. However, it is still not clear that the international financial liberalization process has contributed to the integration of financial markets within the East Asian region. In general,. bond market With the relaxation of capital control in East Asian countries, the degree of stock market integration and interdependence has become more intensively concerned to international