Characterizing Co-movements between Indian and Emerging Asian Equity Markets through Wavelet Multi-Scale Analysis

Abstract

(ProQuest: ... denotes formulae omitted.)I. INTRODUCTIONWith significant reforms in the financial sector in India initiated in 1991, Foreign Institutional Investors (FIIs) and Non Resident Indians (NRIs) gained access to Indian stock markets. Additionally, beginning in 1993, the Indian corporate sector also could seek channels of financing and investment in the global markets with the help of Global Depository Receipts (GDR), American Depository Receipts (ADR) and Foreign Currency Convertible Bonds (FCCB). All these financial opportunities contributed to strong improvements in market capitalization, liquidity and the efficiency of the Indian capital market. In addition, there has been a significant increase in its cross-border flows (capital as well as financial) and as a result, India is currently witnessing an unprecedented level of economic interdependence with both developed and developing nations. The study of economic and market interdependence hold important implications for the theory of financial economics which posits that portfolio risk can be reduced through international portfolio diversification provided that the returns in different markets are weakly or negatively correlated (Markowitz, 1952). A major argument regarding stock market interdependence was laid by (Stulz, 1999) who asserted that increased market integration leads to international risk sharing resulting in lower cost of equity capital. Since the first empirical work on the advantages of internationally well-diversified portfolio (Grubel, 1968), there has been a substantial debate in international finance on the linkages between stock markets and their effects on diversification. Since then, a number of studies have emerged on the co-movements among international equity markets (Levy and Sarnat, 1970; Shiller, 1989; Kasa, 1992; Richards, 1995; Forbes and Rigobon, 2002; Johnson and Soenen, 2003; Brooks and Del Negro, 2004; Syriopoulos, 2007). Initially the investigations on stock market linkages were pursued through simple correlation (Granger and Morgenstern, 1970; Brooks and Del Negro 2004; Mukherjee, 2007). Recently more advanced tools like rolling window correlation (Brooks and Del Negro, 2004), switching regimes (Hassler, 1995) and cointegration methods (Arshanapalli and Doukas, 1993; Voronkova, 2004) have also been used. In Asian markets, empirical works based on co-integration of equity markets have examined the extent to which such markets in the region are correlated, in order to scrutinize the diversification opportunities (Mills and Mills, 1991; Huang et al., 2000; Masih and Masih, 2001; Ratanapakorn and Sharma, 2002). Other studies like (Corhay et al., 1993; Chung and Liu, 1994; Islam, 2014) incorporated vector auto-regression, vector error correction model, impulse response analysis, forecast error variance decomposition and granger causality techniques. Additionally, bivariate GARCH models have been used to investigate the degree of market integration (Kang and Yoon, 2011). The idea was to bring different kinds of tools so as to capture an unambiguous linkage between the underlying markets. However, the methodological experimentations led the authors to two different schools of thoughts. Some propounded that there is essentially a long run relationship, while others argued that the relationship is exclusively short-term. But the fact remains that the authors have overlooked the fact that the problems hinged on co-integration, error correction techniques and the like. For instance, these models have been constructed to deal with not more than two time frequencies.After the significant policy shifts in the beginning of the 1990's, the Indian equity market is swiftly integrating with the rest of the world markets. India is active in various bilateral trade agreements with several countries and regional groups across Asia and Europe. The interdependence and integration of its market is clearly reflected in the rising volatility from spillover turmoil emerging from international markets. …