Abstract
Interdependence in trade and financial globalization has increased the vulnerability of developed and developing countries to external shocks alike, whereas emerging markets are more vulnerable to the shocks originating from the world’s leading economies. This paper investigates the impact of the uncertainty from the global economic policy on the return of the Indonesian stock market by using the time-varying correlation based on the rolling window method and time-varying built dynamic conditional correlation method. Both the rolling window and condition correlation estimates indicate that the correlation between global policy uncertainty and Indonesian stock returns is time-varying. The results of the autoregressive distributed lag-based regression indicate that inflation, global crude oil prices, gross domestic product, and world crude oil production have significant impacts on the dynamic conditional correlation. The average negative estimate of time-varying correlation suggests that investors when faced with liquidity constraints in one country may sell off their assets in another country to raise funds in order to meet their future financial needs. This also indicates that the rise in the uncertainty of economic policy in developed markets has a negative impact on the shocks faced by the Indonesian stock market. Based on our empirical findings, it is recommended that Indonesian policymakers should place more focus on the sustainability of the economic growth, pay close attention to volatile crude oil prices, world crude oil production, and inflation so as to avoid dynamic interaction between the uncertainty of economic policy in the developed markets and the return of the Indonesian stock market.
Highlights
IntroductionThe second contribution of our paper to the empirical literature on economic policy uncertainty and stock market returns is that our paper is the first paper employing both rolling window correlation [45] and the dynamic conditional correlation method [46] to examine the interaction between the Indonesian equity market and the uncertainty of economic policy in the developed markets
Trade liberalization and financial integration in the emerging markets are at the liberalization and financial in the emerging markets trade are atand the heartTrade of policy making and research
The global stock marketeconomies tumbles, are and inclined the global is exposed to vulnerability
Summary
The second contribution of our paper to the empirical literature on economic policy uncertainty and stock market returns is that our paper is the first paper employing both rolling window correlation [45] and the dynamic conditional correlation method [46] to examine the interaction between the Indonesian equity market and the uncertainty of economic policy in the developed markets. We expand on the above work to determine the factors that explain the time-varying-based dynamic conditional correlation between the uncertainty of economic policy in the developed markets and the return of the Indonesian stock market. Tests whether oil price shocks, macroeconomic variables, and recessionary indicators affect the dynamic conditional correlations between global economic policy uncertainty and Indonesian stock market return.
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