Stock Market Linkages in Emerging Asia-Pacific Markets

Srinivasan Palamalai,Kalaivani M,Christopher Devakumar

doi:10.1177/2158244013514060

Abstract

This study examines the stock market integration among major stock markets of emerging Asia-Pacific economies, viz. India, Malaysia, Hong Kong, Singapore, South Korea, Taiwan, Japan, China, and Indonesia. The Johansen and Juselius multivariate cointegration test, Granger causality/Block exogeneity Wald test based on the vector error correction model (VECM) approach, and variance decomposition analysis were used to investigate the dynamic linkages between markets. Cointegration test confirmed a well-defined long-run equilibrium relationship among the major stock markets, implying that there exists a common force, such as arbitrage activity, which brings these stock markets together in the long run. The results of Granger causality/Block exogeneity Wald test based on VECM and variance decomposition analysis revealed the stock market interdependencies and dynamic interactions among the selected emerging Asia-Pacific economies. This result implies that investors can gain feasible benefits from international portfolio diversification in the short run. On the whole, the study results suggest that although long-term diversification benefits from exposure to these markets might be limited, short-run benefits might exist due to substantial transitory fluctuations.

Highlights

Over the last three decades, degree of integration of stock markets around the globe increased significantly as a result of liberalization of markets, rapid technological progress, and financial innovations, which has created new investment and financing opportunities for business and investors around the world. Stulz (1981) defined stock markets as being integrated “if assets with perfectly correlated returns have the same price, regardless of the location in which they trade.” A fully integrated market is defined as a situation where investors earn the same risk-adjusted expected return on similar financial instruments in different national markets (Jorion & Schwartz, 1986), which means arbitrage profit will not be achieved
The results indicate that the Granger causality test based on the vector error correction model (VECM) passes through all diagnostic tests where there is no evidence of autocorrelation and heteroskedasticity in the residuals
Johansen and Juselius (1990) multivariate cointegration test, Granger causality/Block exogeneity Wald test based on VECM approach, and variance decomposition analysis was used to investigate the dynamic linkages between markets

Summary

Introduction

Over the last three decades, degree of integration of stock markets around the globe increased significantly as a result of liberalization of markets, rapid technological progress, and financial innovations, which has created new investment and financing opportunities for business and investors around the world. Stulz (1981) defined stock markets as being integrated “if assets with perfectly correlated returns have the same price, regardless of the location in which they trade.” A fully integrated market is defined as a situation where investors earn the same risk-adjusted expected return on similar financial instruments in different national markets (Jorion & Schwartz, 1986), which means arbitrage profit will not be achieved. The stock market integration hypothesis stated that there were potential gains from international portfolio diversification if returns from investment in different national stock markets are not perfectly correlated and the correlation structure is stable. This implies that low levels of co-movement of stock prices offer investors the benefit of diversifying their holdings across the global stock markets. The correlation analysis is performed to ascertain the degree of association among the emerging stock markets, cointegration test to verify whether long-term relationship exists, and the VECM to examine whether returns of one market influence another.

Literature Review

Method

Findings

Conclusion