Description
This paper aims to seek to find answers to three questions. First, is there any possibility of
long-term cointegration between East and Southeast Asian equity markets? If so, how many
cointegrating equations are there? Second, what are the short-term causal relationships between equity
markets in East and Southeast Asia? Third, what is the East Asia’s most influential equity market
toward their Southeast counterparts, and vice versa?
Journal of Financial Economic Policy
Integration between East and Southeast Asian equity markets
Nuruzzaman Arsyad
Article information:
To cite this document:
Nuruzzaman Arsyad , (2015),"Integration between East and Southeast Asian equity markets", J ournal
of Financial Economic Policy, Vol. 7 Iss 2 pp. 104 - 121
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Integration between East and
Southeast Asian equity markets
Nuruzzaman Arsyad
Sampoerna School of Business, Universitas Siswa Bangsa Internasional,
Jakarta, Indonesia
Abstract
Purpose – This paper aims to seek to fnd answers to three questions. First, is there any possibility of
long-term cointegration between East and Southeast Asian equity markets? If so, how many
cointegrating equations are there? Second, what are the short-termcausal relationships between equity
markets in East and Southeast Asia? Third, what is the East Asia’s most infuential equity market
toward their Southeast counterparts, and vice versa?
Design/methodology/approach – This study uses Johansen’s (1988) cointegration method to test
long-run relationships among East and Southeast Asian equity markets. With regards to short-run
causal relationships, this study uses Granger-causality test as well as the forecast variance
decomposition method.
Findings – Johansen test proves that there is cointegration between East and Southeast Asian equity
markets, but the integration process is not complete. Cointegrating vector also provides evidence that
member countries of ASEAN?3 respond differently to external shocks. With regards to short-run
causal direction, this study fnds that Japan Granger-causes all equity markets in Southeast Asia, while
Singapore and Vietnam Granger-cause all equity markets in East Asia. These results imply that Japan
is the market with most linkages in Southeast Asia, while Singapore and Vietnamare the markets with
most linkages to East Asia. Furthermore, forecast variance decomposition reveals that Japan is the East
Asia’s most infuential equity markets, while Singapore is the most infuential equity market in
Southeast Asia. This study suggests that policymakers in East and Southeast Asian countries to
synchronize the capital market standards and regulations as well as to reduce the barriers for capital
mobility to spur the regional equity market integration.
Research limitations/implications – Increasing integration of East and Southeast Asian capital
markets forces policymakers in ASEAN?3 countries to synchronize monetary policies, as it has been
found that regionally integrated capital markets reduce the degree of independent monetary policy
(Logue et al., 1976). It is therefore important for policymakers in East and Southeast Asian countries to
assess the possibility of stock market integration within this region to anticipate the future risks
associated with economic integration as well as to build collective regional institutions (Wang, 2004).
Click and Plummer (2005) also argued that integrated stock markets is more effcient than nationally
segmentedequitymarkets, andthe effciencyof Asiancapital markets has beenquestionedinparticular
after the 1997 Asian fnancial crises. Yet, the empirical evidence on the extent of fnancial integration
among ASEAN?3 member countries has been limited and inconclusive. This study is therefore an
attempt to investigate the recent development of ASEAN?3 equity markets integration.
Practical implications – This study focuses its attention on the existence and the extent of fnancial
integration in East and Southeast Asia region, and it provides evidence that equity market integration
in ASEAN?3 is far from complete, and for that reason, there is a need for policymakers in ASEAN?3
member countries to synchronize their standards and regulations. Furthermore, the policymakers in
East and Southeast Asia can gain beneft from this study, as it provides the evidence that ASEAN?3
JEL classifcation – C22, F36, G15
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1757-6385.htm
JFEP
7,2
104
Received23 February2014
Revised17 July2014
Accepted22 September 2014
Journal of Financial Economic
Policy
Vol. 7 No. 2, 2015
pp. 104-121
©Emerald Group Publishing Limited
1757-6385
DOI 10.1108/JFEP-02-2014-0012
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member countries respond differently to policy shocks, which may hinder the development of regional
fnancial integration as well as the policy effectiveness of region-wide authority in ASEAN?3.
Originality/value – This research is different from previous studies, as it puts the regional fnancial
integration within the context of ASEAN?3 frameworks. Unlike previous research that considers East
and Southeast Asian countries as an individual entity, this research considers East and Southeast Asia
into two different blocks, following Tourk (2004) who documented that negotiation process for
ASEAN?3 fnancial integration is conducted in sub-regional level (ASEAN vs East Asia), rather than
national level (country per country basis). Second, this study covers the period after the 1997 Asian
fnancial crisis. As suggested in Wang (2014), that the degree of stock market integration tends to
change around the periods marked by fnancial crises, the updated study on Asian fnancial integration
in the aftermath of 1997 fnancial crises is important to document the development of regional fnancial
integration.
Keywords Economic integration, Financial aspects of economic integration
Paper type Research paper
1. Introduction
Financial integration between East and Southeast Asian countries has burgeoned, as
these two blocks began to initiate ASEAN?3[1] fnancial cooperation and integration.
Under ASEAN?3 initiatives, East Asian and ASEAN countries commit to:
• pool reserves and expand regional safety net through Chiang Mai Initiative;
• reduce restrictions on capital movement across the two sub-regions; and
• deepen local currency bond markets through ASEAN?3 Bond Market Initiative
(Yu et al., 2010; Asian Development Bank, 2013).
Financial integration initiatives appear as the result of increasing intra-regional trade
and investment. Yet, the intra-regional trade and regional fnancial linkage advance at
difference pace, as the latter lags behind. The unbalanced progress of economic and
fnancial integration may infuence the fnancial stability.
Financial integration, either in global or regional level, has strong consequences on
fnancial stability. Theoretically, fnancial integration would beneft the member
countries through effcient allocation of capital (Edison et al., 2002), better
diversifcation of country-specifc risk (Obstfeld, 1994; Acemoglu and Ziliboti, 1997),
lower cost of capital through competitive pressure (Jong and Roon, 2005) and
homogenous market response toward external shocks (Umutlu et al., 2010). Within the
context of ASEAN?3, a closer fnancial linkage in the region can help East and
Southeast Asian markets to reduce their capital dependence over US or European
economies (Kim and Lee, 2012). Consequently, regional fnancial integration upgrades
the capacity of member countries to absorb capital, moderates the problem of capital
scarcity in the region and, at the end, enhances economic growth. On the other hand,
fnancial integration may facilitate the cross-border contagion and systemic risk in
fnancial market (Tai, 2004 and Fecht et al., 2012), resulting in more rapid transmission
of fnancial instability among member countries.
One important facet of fnancial integration is the linkage among member countries’
equity markets. Intra-region stock market linkage indicates the existence of free fow of
capital across member countries as well as equity markets’ uniform reactions toward
external shocks. Moreover, Increasing integration of East and Southeast Asian capital
markets may force policymakers in ASEAN?3 countries to synchronize monetary
105
East and
Southeast
Asian equity
markets
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policies, as it has been found that regionally integrated capital markets reduce the
degree of independent monetary policy (Logue et al., 1976). It is therefore important for
policy makers in East and Southeast Asian countries to assess the possibility of stock
market integration within this region to anticipate the future risks associated with
economic integration as well as to build collective regional institutions (Wang, 2004).
Click and Plummer (2005) also argued that integrated stock markets is more effcient
than nationally segmented equity markets, and the effciency of Asian capital markets
has been questioned in particular after the 1997 Asian fnancial crises. Yet, the empirical
evidence on the extent of fnancial integration among ASEAN?3 member countries has
been limited and inconclusive. Previous studies on Asian economic integration focused
mainly on equity market linkage within sub-region prior to 1997 Asian fnancial crises
(Palac-McMiken, 1997; Roca et al., 1998), equity market linkage in East or Southeast
Asia after 1997 fnancial crisis (Click and Plummer, 2005; Jeon et al., 2006; Guillaumin,
2009)or Asian equity market linkage with major stock markets in the world. (Hung and
Cheung, 1995; Yang et al., 2003). Systematic studies on the equity market linkages
between two blocks of East and Southeast Asia, in particular the linkage after 1997
Asian fnancial crises, remain unexplored. As suggested in Wang (2014) that degree of
stock market integration tends to change around the periods marked by fnancial crises,
the updated study on Asian fnancial integration in the aftermath of 1997 fnancial crises
is important to document the development of regional fnancial integration.
This study therefore is an attempt to redress this defciency. Specifcally, this study
seeks to fnd answers to three questions. First, is there any possibility of long-term
cointegration between East and Southeast Asian equity markets? If so, how many
cointegrating equations are there? Second, what are the short-term causal relationships
between equity markets in East and Southeast Asia? Third, what is the East Asia’s most
infuential equity market toward their Southeast counterparts, and vice versa?
This study, however, neither develops the best policy response toward the fnancial
integration nor provides the strategy to achieve complete integration in East and
Southeast Asian equity markets. This study focuses its attention on the existence and
the extent of fnancial integration in East and Southeast Asia region. The rest of the
paper will be organized as follows. Literatures on fnancial integration, in particular
fnancial integration in Asia, are reviewed frst. Third section reviews the data and
methodology used in this research. Results and discussion are presented in the fourth
section, followed by conclusion.
2. East and Southeast Asian equity markets
Equity markets in East Asia have been operating since late 1800s, except the South
Korea stock exchange which started in 1950s. Compared to their East Asian
counterparts, Southeast Asian equity markets are relatively young, with most of them
opened in the mid-1980s and mid-1990s. Due to age difference, East and Southeast Asian
equity markets are different in terms of size. Table I displays the basic information for
each equity markets in East and Southeast Asia.
Table I shows that Japan equity market is the biggest equity market in East and
Southeast Asia, while Vietnam equity market is the smallest. Data also show that
market capitalization in East Asian (Hong Kong, Japan, Shanghai and South Korea) is
six times as big as market capitalization in Southeast Asia; the same ratio applies to
number of listed frms as well. The relatively smaller size of Southeast Asian equity
JFEP
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Table I.
Equity markets
features in East and
Southeast Asia
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107
East and
Southeast
Asian equity
markets
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markets exposes them to higher growth opportunity, and for that reason, Southeast
Asian equity market indices have been growing more rapidly than East Asian indices.
The weighted average 10-year annualized growth rate of equity indices in East Asia is
5.24 per cent, while in Southeast Asia it is 12.92 per cent. These facts are the evidence
that the gap exists between East Asian emerged equity markets and their emerging
counterparts in Southeast Asia.
Due to differences in resources endowments and open economic policy, trade and
foreign direct investments relationship between two regions are signifcantly high and
increasing continually (Langhammer, 1995), suggesting that the equity markets in these
two regions are also closely connected. The Table II below displays the trade and
investment relationships between East and Southeast Asian countries.
Table II shows that ASEANcountries’ exports to China, Japan and South Korea have
increased rapidly above the growth of ASEANexports to the rest of the world as well as
above intra-ASEAN exports. The same stories are found in ASEAN imports from East
Asian countries. With regards to foreign direct investment (FDI) fows to ASEAN
countries, Table II shows that ASEAN FDI infow from China has been growing
signifcantly above the growth of FDI infow from the rest of the world. Although the
growth rate of FDI infow from Japan to ASEAN is only 11.3 per cent, but in terms of
magnitude, Japanese investments in Southeast Asia is the highest among East Asian
countries.
In addition to the close relations in the real sector, East and Southeast Asian
policymakers also put efforts to liberalize capital movement across two regions under
the ASEAN?3 initiatives. ASEAN?3 initiatives, such as Chiang Mai Initiatives and
ASEAN?3 Bond Markets Initiative, intend to boost physical connectivity across two
Table II.
Trade and
investment fow
between ASEAN and
East Asian countries
(in US billion)
Variables 2007 2008 2009 2010 2011 5-year growth rate (%)
ASEAN exports to
China 77.9 87.6 81.6 113.0 127.9 10.4
Japan 85.1 105.9 78.1 102.9 145.2 11.3
South Korea 29.5 36.6 34.3 45.0 54.5 13.1
Intra-ASEAN 217.3 249.9 199.6 268.0 327.5 8.6
Rest of the world 450.0 497.5 416.9 542.0 587.2 5.5
ASEAN imports from
China 93.2 109.3 96.6 119.0 152.5 10.3
Japan 87.9 108.5 82.8 103.7 128.1 7.8
South Korea 31.7 41.7 40.4 53.6 70.0 17.2
Intra-ASEAN 184.6 220.1 176.6 251.8 270.7 8.0
Rest of the world 353.5 440.0 329.9 446.7 525.0 8.2
ASEAN FDI infow from
China 1.7 1.9 4.2 2.9 6.0 28.7
Japan 8.8 4.1 3.8 8.4 15.0 11.3
South Korea 2.7 1.6 1.3 3.7 2.1 ?4.9
Intra-ASEAN 9.6 9.4 5.3 12.3 26.3 22.3
Rest of the world 22.3 17.5 7.9 17.1 64.7 23.7
Source: ASEAN Secretariat
JFEP
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regions (Cowen et al., 2006). Furthermore, ASEAN countries have been working
together to harmonize capital market standards/regulations through ASEAN Capital
Market Forum. These harmonization efforts include harmonization in disclosure
requirements, distribution rules, accounting and auditing standards and mutual
recognition of market professionals’ qualifcations.
Empirical studies have documented evidence on the equity market integration in
East and Southeast Asia, and those studies can be divided into two generations. The
frst generation of research studies the equity market integration prior to 1997 Asian
fnancial crises, while the second generation covers the period after the 1997 Asian
fnancial crises. Among the research that covers the period before 1997 fnancial crises
is by Palac-McMiken (1997), who observed the existence of long-run cointegration
among ASEAN equity markets, with the exception of Indonesia. On the other hand,
Roca et al. (1998) did not confrm the long-run cointegration among ASEAN equity
markets but found that ASEAN equity markets are linked each other in the short-run
and again with the exception of Indonesia. Furthermore, Roca et al. (1998) also found
that Malaysia stock exchange is the most infuential stock market in ASEAN, while
Singapore and Thailand are the markets with most linkages to other equity markets in
ASEAN. Masih and Masih (1999), one of the frst studies connecting Asian and the
World’s equity markets, found that Asian equity markets are related closer to regional
markets with Hong Kong acts as the leading markets. Forbes and Rigobon (2002)
advanced the study of Asia fnancial integration by developing a method to reduce bias
in heteroskedasticity and found that Hong Kong and Philippines equity markets do not
have contagion effects on each other, but both of them are interdependent. On the other
hand, Manning (2002) found that Southeast Asian equity markets were converging
during 1990s, but 1997 fnancial crises interrupted the integration process. Furthermore,
Kimet al. (2006) conducted study of capital movement in 10 Asian countries, who found
stronger fnancial integration during 1980-1990 than 1960-1979.
Among the second-generation studies that cover post 1997 Asian fnancial crises is
Kawai (2005) who noted that increasing fnancial integration in Asia was supported by
increasing FDI and FDI-related trade within the region. In contrast, Jeon et al. (2006)
found that increasing fnancial integration in Asia after fnancial crises is mainly due to
increasing linkage between individual Asian equity markets and global markets, rather
than the linkage among Asian markets. The result of Jeon et al. (2006) is confrmed by
Borensztein and Loungani (2010), who found that Asian countries are more fnancially
integrated with other countries outside the region than with those within the region,
despite the cross-border equity and bond holders among Asian countries are increasing.
Click and Plummer (2005) conducted a study investigating the equity markets
integration in ASEAN using cointegration technique. Click and Plummer (2005) found
that ASEAN stocks markets are cointegrated and, therefore, not segmented by border,
although the integration is far from complete, as there is only one cointegrating
equation. Moreover, Chi et al. (2006) showed that fnancial integration in East Asia has
intensifed during 1991-2005, and this fnding is correlated with the improved fnancial
effciency in this region. Using the panel unit root and panel cointegration test,
Guillaumin (2009) found the evidence of increasing equity markets integration in East
Asia. Additionally, Guillaumin (2009) showed that high-income countries have stronger
fnancial linkage than middle-income countries. Consistent with the results of
Guillaumin (2009), Dhanaraj et al. (2013) found that stock markets in Asian newly
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industrialized economies are infuenced heavily by US stock markets, especially after
the 1997 fnancial crises. The infuence of US stock markets makes the Asian fnancial
system not immune to external shocks and, therefore, may cause the co-movement
among Asian equity markets.
Other notable discussions are Yu et al. (2010), Kimand Lee (2012) and Gong and Kim
(2013). Yu et al. (2010) showed that equity markets integration process in Asia has
increased during 2007-2008 after the slowdown during 2002-2006 as the result of
fnancial crises. Furthermore, Yu et al. (2010) also found that level of integration among
advanced countries is different from that of emerging countries, which may be due to
different institutional quality. In line with Yu et al. (2010), Kimand Lee (2012) found that
correlation coeffcient among East and Southeast Asian equity markets has increased
after Asia fnancial crises, but the fnancial integration has been lagging behind the real
integration. On the other hand, Gong and Kim (2013) found that fnancial integration in
East and Southeast Asia has negative impact on regional business cycle co-movement,
but brings positive impact on trade integration. The latest research about East Asia
fnancial integration is probably by Wang (2014), who found that 2008 global fnancial
crises helps to boost the stock market linkage in Asia. Wang (2014) also found that Hong
Kong and Singapore stock markets dominance in Asia have declined over time, while
the importance of South Korea and Japan stock markets to other Asian stock markets
are increasing.
This research is different from previous studies, as it puts the regional fnancial
integration within the context of ASEAN?3 frameworks. Unlike previous research that
consider East and Southeast Asian countries as individual entity, this research
considers East and Southeast Asia into two different blocks, following Tourk (2004)
who documented that negotiation process for ASEAN?3 fnancial integration is
conducted in sub-regional level (ASEAN vs East Asia), rather than national level
(country per country basis). Therefore, the frst step is to investigate the intra-region
fnancial integration in both East and Southeast Asian blocs, followed by the testing of
inter-regional fnancial integration between the two blocs. Finally, the result for
short-run causal linkage between individual market in ASEAN and individual market
in East Asia is also presented.
3. Data and methodology
Data were collected from Thomson Reuters Datastream and are weekly data covering
the ten-year period from July 2003 to July 2013. The stock indices are Hang Seng Index
for Hong Kong, Nikkei-225 for Japan, Korea Composite Stock Price Index for South
Korea, Shanghai Stock Exchange Composite Index to represent mainland China, Jakarta
Composite Index for Indonesia, Kuala Lumpur Composite Index for Malaysia,
Philippines Stock Exchange Index for the Philippines, Strait Times Index for Singapore,
Thailand Stock Exchange Index for Thailand and Vietnam Stock Index for Vietnam.
The use of weekly data prevents some problems associated with daily and monthly
data. Daily data are deemed to have too much noise (Bailey and Stulz, 1990), while
monthly data are affected by the month of the year effect. The choice of the period is
appropriate, as it corresponds to the period when ASEAN?3 initiatives started to
emerge. Table III below presents the descriptive statistics of data used in this research.
The last column of Table III shows the results of Jarque-Bera test for each equity index,
which confrm the non-normality of all equity indices in East and Southeast Asia.
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Long-run cointegration is tested through Johansen (1988) cointegration procedure,
which allows the determination of long-term relationship among non-stationary
variables, despite the possibility that variables being tested are moving in the opposite
direction in the short-run. The Johansen cointegration procedure requires the dataset to
be stationary at frst-differenced form, which is tested using Augmented Dicky–Fuller
(ADF) test. The results of ADF test are shown in Table IV below.
ADF test results confrmthat all equity market indices are non-stationary in the level
but stationary in the frst-differenced form. The next step is to implement Johansen
(1988) procedure, which based on vector autoregressive (VAR) framework. The
Johansen cointegration can be written in an error-correction form, as in equation (1)
below:
?Xt ? ?
0
? ?
1
?X
t?1
? ?
2
?X
t?2
? ?
k?1
? · · · ? ?X
t?k?1
? ?X
t?1
? ?t (1)
Table III.
Descriptive statistics
Market Mean SD Minimum Maximum Skewness Jarque-Bera
Hong Kong 18,640.96 4,346.45 9,636.81 30,468.34 ?0.04 14.01**
Japan 11,815.17 2,846.32 7,173.00 18,239.00 0.72 55.93**
Shanghai 2,382.19 1,007.69 1,013.64 5,903.26 1.14 159.27**
South Korea 1,495.55 425.76 677.28 2,197.82 ?0.35 39.30**
Indonesia 2,312.89 1,263.24 504.09 5,155.09 0.40 38.59**
Malaysia 1,195.67 298.49 691.45 1,775.59 0.14 42.66**
Philippines 3,133.29 1,391.22 1,192.83 7,279.87 0.87 66.24**
Singapore 2,614.79 572.29 1,458.78 3,814.38 ?0.29 33.35**
Thailand 824.77 258.88 392.87 1,627.96 1.09 118.63**
Vietnam 458.76 225.30 130.90 1,155.68 1.28 188.20**
Note: **Denotes that the null hypothesis of normality is rejected at 1% signifcance level
Table IV.
Augmented Dickey–
Fuller (ADF) test
Market Level ADF-statistic First Difference ADF-statistic
Hong Kong ?2.2366 ?22.5867
Japan ?1.4957 ?22.3973
Shanghai ?1.2956 ?13.6569
South Korea ?1.8461 ?23.1599
Indonesia ?0.0257 ?25.4736
Malaysia ?0.6613 ?22.0432
Philippines 0.3559 ?22.9317
Singapore ?1.9545 ?22.1508
Thailand ?0.3478 ?13.7504
Vietnam ?1.9016 ?12.7533
Notes: The critical values for ADF t-statistics for the null hypothesis of a unit root are ?2.57 at the
10% signifcance level; ?2.87 at the 5% signifcance level and ?3.44 at 1% signifcance level; for the
level series, the null hypothesis of a unit root is not rejected; for the frst difference series, the null
hypothesis of a unit root is rejected
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Where ?X
t?1
is the error correction term, where ? ? ? ? ?’; the components of the
matrix ?are the short-termcorrection parameters to the long-run relationships refected
in the matrix ?. Johansen cointegration procedures aimto estimate the ?in unrestricted
VAR model and, therefore, test whether the restriction imposed by the rank of ? (i.e.
co-integrating vectors) can be rejected. This study is also interested on the number of
cointegrating equations (k). The cointegration is considered to achieve completion if
number of variables
, or number of equity markets included in the estimation, minus
the number of cointegrating equation (n-k) is equal to one (Click and Plummer, 2005).
Johansen (1988) procedure is chosen over Engle and Granger (1987) to test for
cointegration for several reasons. First, Engle and Granger (1987) rely on the presumed
causal relationship between independent and dependent variable. In this case, Engle
and Granger (1987) may suffer from simultaneous equation bias, as it may fail to
recognize causal direction among equity markets in Asia. Second, Engle and Granger
(1987) are unable to detect more than one cointegrating equation in the case of
multivariate cointegration and this cause inability to verify whether or not the
integration process in ASEAN?3 has achieved perfect completion. On the other hand,
Johansen (1988) can detect more than one cointegrating equation for multivariate setting
and, therefore, is more appropriate to answer the frst objective of this study.
The second objective of this study is to fnd the short-run causality direction between
East and Southeast Asian equity markets. Therefore, the result of cointegration test is
followed by Granger causality test. Granger (1969) causality test examined which
variable moves frst followed by other variable. For the purpose of this research,
Granger causality test provides the short-run causal direction among equity markets in
the ASEAN?3 region. If there is signifcant evidence that equity market X
Granger-causes equity market Y, that can be interpreted that shock in X is followed by
shock in Y. If the results show that equity market X Granger-causes Y and Y also
Granger-causes X, then X and Y are said to have bidirectional short-run linkage. Click
and Plummer (2005) suggest the importance of lag chosen in Granger causality, and this
study chooses eight weeks as the maximum lag length for Granger causality test.
The third objective is to determine the most infuential equity market in East Asia
toward their counterparts in Southeast Asia, and vice versa. This question can be
answered by carrying out forecast variance decomposition, which offers the explanation
of VAR systemdynamics. Forecast variance decomposition examines the proportion of
the changes in a particular equity market, arising out of random shocks, that can be
attributed to random shocks coming from other markets in the ASEAN?3 region.
Variance decomposition determines how much the forecast error variance of a given
variable is explained by the change of explanatory variables. There are two results
presented in this analysis. First, forecast variance decomposition of random shocks on
Southeast Asian equity market due to shocks coming from East Asian market. Second
are the results of forecast variance decomposition performed to each East Asian equity
market with the purpose to observe the contribution of each Southeast Asian market to
the random shock in East Asian equity markets.
4. Results and discussion
This section discusses the results of Johansen cointegration tests to check for long-run
equity market linkage, Granger causality test to check for short-run causality direction
and forecast variance decomposition for each market in East and Southeast Asia.
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Table V presents the results of multilateral Johansen cointegration test for equity
markets in East and Southeast Asia. The cointegration analyses are divided into four
segments, cointegration within sub-regions (cointegration among East Asian and
cointegration among Southeast Asian equity markets), cointegration between East
Asian bloc and individual market from Southeast Asia, cointegration between
Southeast Asian bloc and individual market from East Asia and cointegration between
East and Southeast Asia equity markets.
Second column in Table Vdisplays the results of Johansen cointegration test for East
Asian bloc, while the second column displays the results for Southeast Asian bloc.
Lastly, fourth column shows the cointegration test for all East and Southeast Asian
equity markets. Panle Aof Table Vdisplays the results where the alternative hypothesis
posits one cointegrating vectors, while second panel of Table V show the results with
Table V.
Multilateral co-
integration results
based on Johansen
criteria
Variable
Coverage
East Asia Southeast Asia East and Southeast Asia
Panel A. H0: r ? 0; Ha: r ? 1
Optimal lag 2 1 1
Trace statistic 52.438* 101.641* 272.126*
Cointegrating vectors
Japan 1.000 1.000
Hong Kong ?6.279** (1.171) 0.776** (0.228)
Shanghai 14.116** (2.772) 0.004 (0.560)
South Korea 34.307** (8.856) 0.076 (2.319)
Indonesia 1.000 ?7.285** (1.716)
Malaysia ?3.631** (0.393) 44.524** (5.222)
Philippines ?0.445** (0.096) 3.003** (1.139)
Singapore ?0.236 (0.173) ?9.868** (2.254)
Thailand 1.651** (0.364) ?17.039** (3.305)
Vietnam 1.642** (0.273) ?18.135** (3.150)
Panel B. H0: r ? 1; Ha: r ? 2
Optimal lag 2 1 1
Trace statistic 22.486 55.979 203.578*
Cointegrating vectors N/A N/A
Japan 0.000
Hong Kong 1.000
Shanghai ?13.307** (5.597)
South Korea ?131.67** (30.24)
Indonesia 165.72** (21.78)
Malaysia ?332.03** (64.77)
Philippines ?83.709** (14.77)
Singapore 10.697 (22.259)
Thailand 148.42** (43.336)
Vietnam 221.22** (40.34)
Notes: The Johansen (1988) test is used to test multivariate cointegration with critical values of 95%;
the r denotes the maximum number of cointegrating vectors; *denotes signifcance at 5% level;
standard error is in parentheses; **denotes signifcance at 1% level
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alternative hypothesis of more than one cointegrating equations. Optimal lag for
Johansen cointegration test is chosen based on Schwarz information criteria.
The results of the frst column present the cointegration test within East Asian
sub-regions. The results indicate that East Asian equity markets are integrated as
evident by Johansen cointegration test that is signifcant at 95 per cent level. The
cointegrating vector for East Asia, which is normalized around Japan equity market, can
be written as in equation (2) below:
Japan ?6.28 Hongkong ? 14.12 Shanghai ? 34.31 S.Korea (2)
According to the cointegrating vectors in equation (2), only Hong Kong equity market
has positive long-run relationship with Japan, where 1 per cent positive shock in Hong
Kong index results in 6.28 per cent positive shock in Japan stock market index. On the
other hand, Shanghai and South Korea stock markets have negative relationship with
that of Japan, where 1 per cent increase in Shanghai and South Korea stock market can
cause decrease in Japan index by 14 and 34 per cent, respectively. Although the
coeffcient of Shanghai and South Korea equity market does not make sense
economically, but the sign reveals that Shanghai and South Korean react to the shocks
differently from Japan and Hong Kong reactions. Furthermore, The Johansen
cointegration test shows that there is only one cointegrating vectors (k), whereas there
are four equity markets in East Asia, resulting in n-k is equal to three. This means
that the integration process in East Asian is not complete, but there remains the
opportunity for fnancial integration within this sub-region.
The second column presents the result of cointegration test for Southeast Asian bloc.
There exists one long-run cointegration relationship among Southeast Asian equity
markets at 95 per cent level of signifcance. The cointegrating vector for Southeast Asia,
which is normalized around Indonesian equity market, can be written as follows:
Indonesia ? 3.63 Malaysia ? 0.45 Philippines ? 0.24 Singapore ? 1.65 Thailand
?1.62 Vietnam
(3)
The cointegrating vector in equation (3) implies that Malaysia, Philippines and
Singapore have positive long-run relationship with Indonesia equity market,
specifcally 1 per cent increase in Malaysia, Philippines and Singapore stock index
results in 3.63, 0.45 and 0.24 per cent increase in Indonesia stock market index,
respectively. On the other hand, 1 per cent increase in Thailand and Vietnam stock
index are associated with 1.65 and 1.62 per cent decrease in Indonesia stock index,
respectively. These results imply that Indonesia, Malaysia, Philippines and Singapore
respond similarly to external shocks, while Thailand and Vietnam respond differently.
This conclusion does not support the fnding of Click and Plummer (2005) who found
that Indonesia does not have positive long-run relationship with Malaysia and the
Philippines. The similarity of economic development level and relatively closer
geographical distance are among the reason of why Indonesia, Malaysia, the Philippines
and Singapore are expected to have uniform respond to policy shock. Furthermore, the
Johansen cointegration results again show that integration process in Southeast Asia is
far from complete, as evident by only one cointegrating vector.
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The last column of Table V presents the Johansen cointegration test for East and
Southeast Asian equity markets altogether. According to trace statistic, there exist two
cointegrating equations at 95 per cent level of signifcance among equity markets in
East and Southeast Asia. Again, the cointegration test confrms that the integration
process is not complete, as n-k is more than one. The frst cointegrating equation is
normalized around Japan and can be written as:
Japan ? ?0.77 Hongkong ? 0.004 Shanghai ? 0.08 S.Korea ? 7.29 Indonesia
?44.52 Malaysia ? 3.00 Philippines ? 9.89 Singapore ? 17.04 Thailand
?18.14 Vietnam
(4)
Equation (4) shows that Japan stock market has positive relationship with Indonesia,
Singapore, Thailand and Vietnam, and negative long-run relationship with Hong Kong,
Shanghai, South Korea, Malaysia and the Philippines. According to the result, 1 per cent
increase in Hong Kong, Shanghai, South Korea, Malaysia and the Philippines results in
decrease of Japan stock index by 0.77 per cent, 0.004, 0.08, 44.52 and 3 per cent,
respectively. Except for Malaysia, the coeffcient is economically signifcant. On the
other hand, 1 per cent increase in Indonesia, Singapore, Thailand and Vitenam result in
increase of Japan stock market index by 7.29, 9.89, 17.04 and 18.14 per cent, respectively.
From the perspective of regional policy initiation, these results may indicate that East
and Southeast Asian equity markets may respond differently to regional policy shocks,
where the reaction Japan, Indonesia, Singapore, Thailand and Vietnammay be different
from the reaction of Hong Kong, Shanghai, South Korea, Malaysia and the Philippines.
Unequal responses to external shocks or to policy initiatives may hinder the policy
effectiveness of regional authorities and at the same time increase the dependence over
domestic authority. Therefore, policymakers in East and Southeast Asian countries
need to harmonize their capital market regulations following ASEAN?3 capital market
development frameworks to ensure uniform responses to policy incentives.
The second question posed by this study is the short-run causality directions
between East and Southeast Asian equity markets. In this sub-section, the Granger
causality test performed by pairing individual market in East Asia and individual
market in Southeast Asia. Table VI below presents the results of Granger causality
tests.
The frst column shows any possible combination when pairing individual market in
East Asia and individual market in Southeast Asia. The second column presents the
F-test for frst market Granger-causes the second market in each pair. The third column
presents the F-test for second market Granger-causes the frst market in each pair.
According to Table VI, Hong Kong is having bidirectional relationship with
Indonesia, the Philippines and Singapore. Hong Kong also has unidirectional causal
relationship with Malaysia and Vietnam, with the results suggesting that Malaysia and
Vietnamequity markets Granger-cause the Hong Kong equity market, but not the other
way around. Moreover, Hong Kong equity market has no causal relation with Thailand
equity market.
Japan equity market, according to results presented in Table VI, is having
bidirectional relationship with Malaysia, Singapore and Vietnam equity markets.
Furthermore, the results suggest that Japan equity market is having unidirectional
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causal relationship Indonesia, the Philippines and Thailand, with the causal directions
goes from Japan to those Southeast Asian markets. These results indicate that Japan
equity market Granger-causes all equity markets in Southeast Asia but is Granger-
caused by Malaysia, Singapore and Vietnam equity markets only.
Shanghai equity market is found to have bidirectional relationship with Malaysia,
Singapore and Vietnam. Shanghai equity market is also found to Granger-cause the
movement in the Philippines equity market, but has no short-run causal relationship
with Indonesia and Thailand. Table VI also suggests that South Korean equity market
has bidirectional causal relation with Singapore and Vietnam. However, South Korea
equity market has no relationship with equity markets in Indonesia, Malaysia, the
Philippines and Thailand. These results reveal that compared to other East Asian
equity markets, South Korea is the least connected toward Southeast Asian equity
markets.
Altogether, the results indicate that Japan equity market movement Granger-causes
all equity markets movement in Southeast Asia, while Singapore and Vietnam
Granger-cause all equity markets movement in East Asia. This implies that Japan is the
East Asian market with most linkages to Southeast Asian equity markets, while
Singapore and Vietnamare the most connected equity market in Southeast Asia toward
Table VI.
Granger causality
test
Market pairs F-test (1) F-test (2)
Hong Kong, Indonesia 1.945** 1.643**
Hong Kong, Malaysia 1.141 1.693**
Hong Kong, the Philippines 1.550* 1.539*
Hong Kong, Singapore 1.514* 1.975**
Hong Kong, Thailand 1.034 1.355
Hong Kong, Vietnam 1.384 2.572**
Japan, Indonesia 2.294** 0.979
Japan, Malaysia 1.676** 1.658**
Japan, the Philippines 2.248** 0.853
Japan, Singapore 3.342** 1.435*
Japan, Thailand 1.885** 1.301
Japan, Vietnam 1.735** 2.316**
Shanghai, Indonesia 1.372 1.257
Shanghai, Malaysia 1.691** 1.590**
Shanghai, the Philippines 2.003** 1.268
Shanghai, Singapore 2.249** 1.931**
Shanghai, Thailand 1.163 0.965
Shanghai, Vietnam 1.947** 2.612**
South Korea, Indonesia 1.258 1.278
South Korea, Malaysia 0.874 1.339
South Korea, the Philippines 1.192 1.196
South Korea, Singapore 1.575** 1.483*
South Korea, Thailand 0.821 1.152
South Korea, Vietnam 1.535* 2.501**
Notes: F-test (1) denotes the Granger causality test for the frst market Granger-causes the second
market; F-test (2) denotes the Granger causality test for the second market Granger-causes the frst
market; **and *denote the signifcance at 1 and 5%, respectively
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their counterparts in East Asia. However, the Granger causality test provides evidence
that not all of equity markets in East and Southeast Asia are connected both on
bidirectional or unidirectional basis. South Korea, for example, has very limited
short-run linkage with Southeast Asian equity markets, which may cause unequal
short-run responses to region-wide policy initiatives. The results of Granger causality
test again indicate that integration process in East and Southeast Asian region is far
from complete. The government of each country may need to take steps to reduce the
barrier for international capital mobility and, therefore, boost the regional fnancial
integration.
The last analysis is the results of forecast variance decomposition method. If the last
sub-section suggests that Japan equity market is having most linkages toward
counterparts in Southeast Asia, is Japan also the most infuential East Asian equity
market? The last sub-section intends to answer this type of question. The analyses in
this sub-section are divided into two parts. The frst part is the decomposition of random
shocks in each Southeast Asian equity market, while the second is the random shocks
decomposition for each East Asian equity market. The former intends to seek the East
Asia’s most infuential equity market, while the latter intends to search for the most
infuential of Southeast Asian equity markets.
Table VII below exhibits forecast variance decomposition results for Southeast
Asian equity markets. The results show that random shocks in Japan equity market
contribute to 11.67 per cent randomshocks in Indonesia, 5.14 per cent of randomshocks
in Malaysia, 9.73 per cent of randomshocks in the Philippines, 16.65 per cent of random
shocks in Singapore, 9.57 per cent of random shocks in Thailand and 2.66 per cent of
random shocks in Vietnam equity market. For any Southeast Asian equity market, the
random shocks coming from random shocks in Japan far outweigh the random shocks
caused by other three East Asian equity markets. In the case of Indonesia, random
shocks coming fromJapan equity market (11.67 per cent) is even higher than cumulative
random shocks contributed by other Southeast Asian equity markets (10.38 per cent).
These results strongly suggest that Japan is the most infuential East Asian equity
market toward Southeast Asian markets.
However, Table VII also reveals that random shocks in Southeast Asian equity
markets are mainly due to domestic shocks. Indonesia and Vietnam equity markets, for
example, are having more than 70 per cent domestic shocks.
Table VIII presents forecast variance decomposition results for East Asian equity
markets. The results indicate that the portion of random shocks in Hong Kong equity
Table VII.
Forecast variance
decomposition
analyses: percentage
changes in ASEAN
market due to
random shocks in
East Asian markets
(4-week time horizon)
Forecast
variance of
Percentage of forecast variance due to
Hong Kong Japan Shanghai South Korea Other ASEAN Markets Domestic shocks
Indonesia 0.14 11.67 0.08 0.27 10.38 77.46
Malaysia 0.16 5.14 0.30 0.06 32.89 61.45
Philippines 0.44 9.73 0.06 2.88 26.00 58.89
Singapore 0.12 16.65 0.09 0.59 34.08 48.47
Thailand 0.03 9.57 0.15 0.87 41.44 47.94
Vietnam 0.54 2.66 0.41 0.46 15.90 80.03
Note: All numbers are in percentage term
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market due to random shocks in Singapore is 33.49 per cent, far outweigh the random
shocks caused by other East Asian equity markets (14.30 per cent) and domestic shocks
(19.77 per cent). Relative to random shocks caused by other Southeast Asian countries,
shocks caused by Singapore are also dominant in the case of Japan (10.77 per cent),
Shanghai (9.92 per cent) and South Korea (19.77 per cent). Random shocks in Hong
Kong, Japan and Shanghai due to Singapore’s random shocks are even higher than
shocks due to other East Asian markets.
Table VIII also reveals that random shocks in Japan and Shanghai equity
markets are mainly due to domestic shocks, but this is not the case in Hong Kong
and South Korea where external random shocks are more dominant. Overall, the
tests confrm that Singapore is the Southeast Asia’s most infuential equity market
toward East Asia.
General conclusion from forecast variance decomposition analysis is that random
shocks in Southeast Asian equity markets caused by Japan is stronger than random
shocks caused by other Southeast Asian equity markets, whereas Singapore’s infuence
toward East Asian markets is the strongest compared to that of other Southeast Asian
equity markets.
5. Conclusion
This study focuses on equity market integration between East and Southeast Asia,
which helps to understand the possibility of fnancial integration under ASEAN?3
initiatives. Although fnancial integration requires the co-movement of macroeconomic
as well as the inter-linkage of fnancial institutions within the region, but the equity
market integration is defnitely one facet of fnancial integration.
This study fnds evidence of long-run cointegration among East and Southeast
Asian equity markets as well as within each East Asian and Southeast Asian
sub-region. However, the integration process is not complete as evident by the
number of cointegrating vectors. The sign of cointegrating vector also indicates that
reactions of Japan, Hong Kong, Indonesia, Singapore, Thailand and Vietnam to
external shocks may be different from the reactions of Shanghai, South Korea,
Malaysia and the Philippines. The results indicate the urgency of ASEAN?3
member countries to harmonize their capital market regulations and standards to
stimulate the integration process. Furthermore, the harmonization of standards and
regulation encourages the equity markets in East and Southeast Asia to respond
equally to external shocks or policy initiative and, therefore, ensure the full benefts
of regional integration.
Table VIII.
Forecast variance
decomposition
analyses: percentage
changes in East Asia
market due to random
shocks in ASEAN
markets (four-week
time horizon)
Forecast
variance of
Percentage of forecast variance due to
Indonesia Malaysia Philippines Singapore Thailand Vietnam
Other East
Asian markets
Domestic
shocks
Hong Kong 15.07 7.85 8.02 33.49 1.33 0.17 14.30 19.77
Japan 0.48 2.56 2.96 10.77 0.43 0.38 0.78 81.64
Shanghai 5.22 5.17 0.33 9.92 0.12 1.37 0.65 77.22
South Korea 13.95 5.94 6.54 19.77 2.41 0.83 21.32 29.24
Note: All numbers are in percentage term
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It is also observed that Japan is the equity markets in East Asia with most linkages to
Southeast Asia, because the movement of Japan equity index Granger-causes the
movement of all Southeast Asian equity market indices. On the other side, Singapore
and Vietnam are the Southeast Asia’s most connected equity markets toward their
counterparts in East Asia.
This study also confrms that Japan is the East Asia’s most infuential equity
markets in East Asia, as random shocks contributed by Japan equity markets to
Southeast Asian equity markets are higher compared to randomshocks caused by other
East Asian equity markets. For similar reason, Singapore is the most infuential equity
market in Southeast Asia because random shocks in East Asian markets caused by
random shocks in Singapore is higher than random shocks caused by other ASEAN
countries.
Note
1. ASEAN?3 countries consist of ASEANcountries (Brunei Darussalam, Cambodia, Indonesia,
Lao PDR, Indonesia, Malaysia, Myanmar, the Philippines, Singapore, Thailand and Vietnam)
and three East Asian countries (China, Japan and South Korea).
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Vol. 50 No. 2, pp. 403-444.
Corresponding author
Nuruzzaman Arsyad can be contacted at: [email protected]
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doc_478695471.pdf
This paper aims to seek to find answers to three questions. First, is there any possibility of
long-term cointegration between East and Southeast Asian equity markets? If so, how many
cointegrating equations are there? Second, what are the short-term causal relationships between equity
markets in East and Southeast Asia? Third, what is the East Asia’s most influential equity market
toward their Southeast counterparts, and vice versa?
Journal of Financial Economic Policy
Integration between East and Southeast Asian equity markets
Nuruzzaman Arsyad
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To cite this document:
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Integration between East and
Southeast Asian equity markets
Nuruzzaman Arsyad
Sampoerna School of Business, Universitas Siswa Bangsa Internasional,
Jakarta, Indonesia
Abstract
Purpose – This paper aims to seek to fnd answers to three questions. First, is there any possibility of
long-term cointegration between East and Southeast Asian equity markets? If so, how many
cointegrating equations are there? Second, what are the short-termcausal relationships between equity
markets in East and Southeast Asia? Third, what is the East Asia’s most infuential equity market
toward their Southeast counterparts, and vice versa?
Design/methodology/approach – This study uses Johansen’s (1988) cointegration method to test
long-run relationships among East and Southeast Asian equity markets. With regards to short-run
causal relationships, this study uses Granger-causality test as well as the forecast variance
decomposition method.
Findings – Johansen test proves that there is cointegration between East and Southeast Asian equity
markets, but the integration process is not complete. Cointegrating vector also provides evidence that
member countries of ASEAN?3 respond differently to external shocks. With regards to short-run
causal direction, this study fnds that Japan Granger-causes all equity markets in Southeast Asia, while
Singapore and Vietnam Granger-cause all equity markets in East Asia. These results imply that Japan
is the market with most linkages in Southeast Asia, while Singapore and Vietnamare the markets with
most linkages to East Asia. Furthermore, forecast variance decomposition reveals that Japan is the East
Asia’s most infuential equity markets, while Singapore is the most infuential equity market in
Southeast Asia. This study suggests that policymakers in East and Southeast Asian countries to
synchronize the capital market standards and regulations as well as to reduce the barriers for capital
mobility to spur the regional equity market integration.
Research limitations/implications – Increasing integration of East and Southeast Asian capital
markets forces policymakers in ASEAN?3 countries to synchronize monetary policies, as it has been
found that regionally integrated capital markets reduce the degree of independent monetary policy
(Logue et al., 1976). It is therefore important for policymakers in East and Southeast Asian countries to
assess the possibility of stock market integration within this region to anticipate the future risks
associated with economic integration as well as to build collective regional institutions (Wang, 2004).
Click and Plummer (2005) also argued that integrated stock markets is more effcient than nationally
segmentedequitymarkets, andthe effciencyof Asiancapital markets has beenquestionedinparticular
after the 1997 Asian fnancial crises. Yet, the empirical evidence on the extent of fnancial integration
among ASEAN?3 member countries has been limited and inconclusive. This study is therefore an
attempt to investigate the recent development of ASEAN?3 equity markets integration.
Practical implications – This study focuses its attention on the existence and the extent of fnancial
integration in East and Southeast Asia region, and it provides evidence that equity market integration
in ASEAN?3 is far from complete, and for that reason, there is a need for policymakers in ASEAN?3
member countries to synchronize their standards and regulations. Furthermore, the policymakers in
East and Southeast Asia can gain beneft from this study, as it provides the evidence that ASEAN?3
JEL classifcation – C22, F36, G15
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1757-6385.htm
JFEP
7,2
104
Received23 February2014
Revised17 July2014
Accepted22 September 2014
Journal of Financial Economic
Policy
Vol. 7 No. 2, 2015
pp. 104-121
©Emerald Group Publishing Limited
1757-6385
DOI 10.1108/JFEP-02-2014-0012
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member countries respond differently to policy shocks, which may hinder the development of regional
fnancial integration as well as the policy effectiveness of region-wide authority in ASEAN?3.
Originality/value – This research is different from previous studies, as it puts the regional fnancial
integration within the context of ASEAN?3 frameworks. Unlike previous research that considers East
and Southeast Asian countries as an individual entity, this research considers East and Southeast Asia
into two different blocks, following Tourk (2004) who documented that negotiation process for
ASEAN?3 fnancial integration is conducted in sub-regional level (ASEAN vs East Asia), rather than
national level (country per country basis). Second, this study covers the period after the 1997 Asian
fnancial crisis. As suggested in Wang (2014), that the degree of stock market integration tends to
change around the periods marked by fnancial crises, the updated study on Asian fnancial integration
in the aftermath of 1997 fnancial crises is important to document the development of regional fnancial
integration.
Keywords Economic integration, Financial aspects of economic integration
Paper type Research paper
1. Introduction
Financial integration between East and Southeast Asian countries has burgeoned, as
these two blocks began to initiate ASEAN?3[1] fnancial cooperation and integration.
Under ASEAN?3 initiatives, East Asian and ASEAN countries commit to:
• pool reserves and expand regional safety net through Chiang Mai Initiative;
• reduce restrictions on capital movement across the two sub-regions; and
• deepen local currency bond markets through ASEAN?3 Bond Market Initiative
(Yu et al., 2010; Asian Development Bank, 2013).
Financial integration initiatives appear as the result of increasing intra-regional trade
and investment. Yet, the intra-regional trade and regional fnancial linkage advance at
difference pace, as the latter lags behind. The unbalanced progress of economic and
fnancial integration may infuence the fnancial stability.
Financial integration, either in global or regional level, has strong consequences on
fnancial stability. Theoretically, fnancial integration would beneft the member
countries through effcient allocation of capital (Edison et al., 2002), better
diversifcation of country-specifc risk (Obstfeld, 1994; Acemoglu and Ziliboti, 1997),
lower cost of capital through competitive pressure (Jong and Roon, 2005) and
homogenous market response toward external shocks (Umutlu et al., 2010). Within the
context of ASEAN?3, a closer fnancial linkage in the region can help East and
Southeast Asian markets to reduce their capital dependence over US or European
economies (Kim and Lee, 2012). Consequently, regional fnancial integration upgrades
the capacity of member countries to absorb capital, moderates the problem of capital
scarcity in the region and, at the end, enhances economic growth. On the other hand,
fnancial integration may facilitate the cross-border contagion and systemic risk in
fnancial market (Tai, 2004 and Fecht et al., 2012), resulting in more rapid transmission
of fnancial instability among member countries.
One important facet of fnancial integration is the linkage among member countries’
equity markets. Intra-region stock market linkage indicates the existence of free fow of
capital across member countries as well as equity markets’ uniform reactions toward
external shocks. Moreover, Increasing integration of East and Southeast Asian capital
markets may force policymakers in ASEAN?3 countries to synchronize monetary
105
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Southeast
Asian equity
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policies, as it has been found that regionally integrated capital markets reduce the
degree of independent monetary policy (Logue et al., 1976). It is therefore important for
policy makers in East and Southeast Asian countries to assess the possibility of stock
market integration within this region to anticipate the future risks associated with
economic integration as well as to build collective regional institutions (Wang, 2004).
Click and Plummer (2005) also argued that integrated stock markets is more effcient
than nationally segmented equity markets, and the effciency of Asian capital markets
has been questioned in particular after the 1997 Asian fnancial crises. Yet, the empirical
evidence on the extent of fnancial integration among ASEAN?3 member countries has
been limited and inconclusive. Previous studies on Asian economic integration focused
mainly on equity market linkage within sub-region prior to 1997 Asian fnancial crises
(Palac-McMiken, 1997; Roca et al., 1998), equity market linkage in East or Southeast
Asia after 1997 fnancial crisis (Click and Plummer, 2005; Jeon et al., 2006; Guillaumin,
2009)or Asian equity market linkage with major stock markets in the world. (Hung and
Cheung, 1995; Yang et al., 2003). Systematic studies on the equity market linkages
between two blocks of East and Southeast Asia, in particular the linkage after 1997
Asian fnancial crises, remain unexplored. As suggested in Wang (2014) that degree of
stock market integration tends to change around the periods marked by fnancial crises,
the updated study on Asian fnancial integration in the aftermath of 1997 fnancial crises
is important to document the development of regional fnancial integration.
This study therefore is an attempt to redress this defciency. Specifcally, this study
seeks to fnd answers to three questions. First, is there any possibility of long-term
cointegration between East and Southeast Asian equity markets? If so, how many
cointegrating equations are there? Second, what are the short-term causal relationships
between equity markets in East and Southeast Asia? Third, what is the East Asia’s most
infuential equity market toward their Southeast counterparts, and vice versa?
This study, however, neither develops the best policy response toward the fnancial
integration nor provides the strategy to achieve complete integration in East and
Southeast Asian equity markets. This study focuses its attention on the existence and
the extent of fnancial integration in East and Southeast Asia region. The rest of the
paper will be organized as follows. Literatures on fnancial integration, in particular
fnancial integration in Asia, are reviewed frst. Third section reviews the data and
methodology used in this research. Results and discussion are presented in the fourth
section, followed by conclusion.
2. East and Southeast Asian equity markets
Equity markets in East Asia have been operating since late 1800s, except the South
Korea stock exchange which started in 1950s. Compared to their East Asian
counterparts, Southeast Asian equity markets are relatively young, with most of them
opened in the mid-1980s and mid-1990s. Due to age difference, East and Southeast Asian
equity markets are different in terms of size. Table I displays the basic information for
each equity markets in East and Southeast Asia.
Table I shows that Japan equity market is the biggest equity market in East and
Southeast Asia, while Vietnam equity market is the smallest. Data also show that
market capitalization in East Asian (Hong Kong, Japan, Shanghai and South Korea) is
six times as big as market capitalization in Southeast Asia; the same ratio applies to
number of listed frms as well. The relatively smaller size of Southeast Asian equity
JFEP
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Table I.
Equity markets
features in East and
Southeast Asia
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107
East and
Southeast
Asian equity
markets
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markets exposes them to higher growth opportunity, and for that reason, Southeast
Asian equity market indices have been growing more rapidly than East Asian indices.
The weighted average 10-year annualized growth rate of equity indices in East Asia is
5.24 per cent, while in Southeast Asia it is 12.92 per cent. These facts are the evidence
that the gap exists between East Asian emerged equity markets and their emerging
counterparts in Southeast Asia.
Due to differences in resources endowments and open economic policy, trade and
foreign direct investments relationship between two regions are signifcantly high and
increasing continually (Langhammer, 1995), suggesting that the equity markets in these
two regions are also closely connected. The Table II below displays the trade and
investment relationships between East and Southeast Asian countries.
Table II shows that ASEANcountries’ exports to China, Japan and South Korea have
increased rapidly above the growth of ASEANexports to the rest of the world as well as
above intra-ASEAN exports. The same stories are found in ASEAN imports from East
Asian countries. With regards to foreign direct investment (FDI) fows to ASEAN
countries, Table II shows that ASEAN FDI infow from China has been growing
signifcantly above the growth of FDI infow from the rest of the world. Although the
growth rate of FDI infow from Japan to ASEAN is only 11.3 per cent, but in terms of
magnitude, Japanese investments in Southeast Asia is the highest among East Asian
countries.
In addition to the close relations in the real sector, East and Southeast Asian
policymakers also put efforts to liberalize capital movement across two regions under
the ASEAN?3 initiatives. ASEAN?3 initiatives, such as Chiang Mai Initiatives and
ASEAN?3 Bond Markets Initiative, intend to boost physical connectivity across two
Table II.
Trade and
investment fow
between ASEAN and
East Asian countries
(in US billion)
Variables 2007 2008 2009 2010 2011 5-year growth rate (%)
ASEAN exports to
China 77.9 87.6 81.6 113.0 127.9 10.4
Japan 85.1 105.9 78.1 102.9 145.2 11.3
South Korea 29.5 36.6 34.3 45.0 54.5 13.1
Intra-ASEAN 217.3 249.9 199.6 268.0 327.5 8.6
Rest of the world 450.0 497.5 416.9 542.0 587.2 5.5
ASEAN imports from
China 93.2 109.3 96.6 119.0 152.5 10.3
Japan 87.9 108.5 82.8 103.7 128.1 7.8
South Korea 31.7 41.7 40.4 53.6 70.0 17.2
Intra-ASEAN 184.6 220.1 176.6 251.8 270.7 8.0
Rest of the world 353.5 440.0 329.9 446.7 525.0 8.2
ASEAN FDI infow from
China 1.7 1.9 4.2 2.9 6.0 28.7
Japan 8.8 4.1 3.8 8.4 15.0 11.3
South Korea 2.7 1.6 1.3 3.7 2.1 ?4.9
Intra-ASEAN 9.6 9.4 5.3 12.3 26.3 22.3
Rest of the world 22.3 17.5 7.9 17.1 64.7 23.7
Source: ASEAN Secretariat
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regions (Cowen et al., 2006). Furthermore, ASEAN countries have been working
together to harmonize capital market standards/regulations through ASEAN Capital
Market Forum. These harmonization efforts include harmonization in disclosure
requirements, distribution rules, accounting and auditing standards and mutual
recognition of market professionals’ qualifcations.
Empirical studies have documented evidence on the equity market integration in
East and Southeast Asia, and those studies can be divided into two generations. The
frst generation of research studies the equity market integration prior to 1997 Asian
fnancial crises, while the second generation covers the period after the 1997 Asian
fnancial crises. Among the research that covers the period before 1997 fnancial crises
is by Palac-McMiken (1997), who observed the existence of long-run cointegration
among ASEAN equity markets, with the exception of Indonesia. On the other hand,
Roca et al. (1998) did not confrm the long-run cointegration among ASEAN equity
markets but found that ASEAN equity markets are linked each other in the short-run
and again with the exception of Indonesia. Furthermore, Roca et al. (1998) also found
that Malaysia stock exchange is the most infuential stock market in ASEAN, while
Singapore and Thailand are the markets with most linkages to other equity markets in
ASEAN. Masih and Masih (1999), one of the frst studies connecting Asian and the
World’s equity markets, found that Asian equity markets are related closer to regional
markets with Hong Kong acts as the leading markets. Forbes and Rigobon (2002)
advanced the study of Asia fnancial integration by developing a method to reduce bias
in heteroskedasticity and found that Hong Kong and Philippines equity markets do not
have contagion effects on each other, but both of them are interdependent. On the other
hand, Manning (2002) found that Southeast Asian equity markets were converging
during 1990s, but 1997 fnancial crises interrupted the integration process. Furthermore,
Kimet al. (2006) conducted study of capital movement in 10 Asian countries, who found
stronger fnancial integration during 1980-1990 than 1960-1979.
Among the second-generation studies that cover post 1997 Asian fnancial crises is
Kawai (2005) who noted that increasing fnancial integration in Asia was supported by
increasing FDI and FDI-related trade within the region. In contrast, Jeon et al. (2006)
found that increasing fnancial integration in Asia after fnancial crises is mainly due to
increasing linkage between individual Asian equity markets and global markets, rather
than the linkage among Asian markets. The result of Jeon et al. (2006) is confrmed by
Borensztein and Loungani (2010), who found that Asian countries are more fnancially
integrated with other countries outside the region than with those within the region,
despite the cross-border equity and bond holders among Asian countries are increasing.
Click and Plummer (2005) conducted a study investigating the equity markets
integration in ASEAN using cointegration technique. Click and Plummer (2005) found
that ASEAN stocks markets are cointegrated and, therefore, not segmented by border,
although the integration is far from complete, as there is only one cointegrating
equation. Moreover, Chi et al. (2006) showed that fnancial integration in East Asia has
intensifed during 1991-2005, and this fnding is correlated with the improved fnancial
effciency in this region. Using the panel unit root and panel cointegration test,
Guillaumin (2009) found the evidence of increasing equity markets integration in East
Asia. Additionally, Guillaumin (2009) showed that high-income countries have stronger
fnancial linkage than middle-income countries. Consistent with the results of
Guillaumin (2009), Dhanaraj et al. (2013) found that stock markets in Asian newly
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industrialized economies are infuenced heavily by US stock markets, especially after
the 1997 fnancial crises. The infuence of US stock markets makes the Asian fnancial
system not immune to external shocks and, therefore, may cause the co-movement
among Asian equity markets.
Other notable discussions are Yu et al. (2010), Kimand Lee (2012) and Gong and Kim
(2013). Yu et al. (2010) showed that equity markets integration process in Asia has
increased during 2007-2008 after the slowdown during 2002-2006 as the result of
fnancial crises. Furthermore, Yu et al. (2010) also found that level of integration among
advanced countries is different from that of emerging countries, which may be due to
different institutional quality. In line with Yu et al. (2010), Kimand Lee (2012) found that
correlation coeffcient among East and Southeast Asian equity markets has increased
after Asia fnancial crises, but the fnancial integration has been lagging behind the real
integration. On the other hand, Gong and Kim (2013) found that fnancial integration in
East and Southeast Asia has negative impact on regional business cycle co-movement,
but brings positive impact on trade integration. The latest research about East Asia
fnancial integration is probably by Wang (2014), who found that 2008 global fnancial
crises helps to boost the stock market linkage in Asia. Wang (2014) also found that Hong
Kong and Singapore stock markets dominance in Asia have declined over time, while
the importance of South Korea and Japan stock markets to other Asian stock markets
are increasing.
This research is different from previous studies, as it puts the regional fnancial
integration within the context of ASEAN?3 frameworks. Unlike previous research that
consider East and Southeast Asian countries as individual entity, this research
considers East and Southeast Asia into two different blocks, following Tourk (2004)
who documented that negotiation process for ASEAN?3 fnancial integration is
conducted in sub-regional level (ASEAN vs East Asia), rather than national level
(country per country basis). Therefore, the frst step is to investigate the intra-region
fnancial integration in both East and Southeast Asian blocs, followed by the testing of
inter-regional fnancial integration between the two blocs. Finally, the result for
short-run causal linkage between individual market in ASEAN and individual market
in East Asia is also presented.
3. Data and methodology
Data were collected from Thomson Reuters Datastream and are weekly data covering
the ten-year period from July 2003 to July 2013. The stock indices are Hang Seng Index
for Hong Kong, Nikkei-225 for Japan, Korea Composite Stock Price Index for South
Korea, Shanghai Stock Exchange Composite Index to represent mainland China, Jakarta
Composite Index for Indonesia, Kuala Lumpur Composite Index for Malaysia,
Philippines Stock Exchange Index for the Philippines, Strait Times Index for Singapore,
Thailand Stock Exchange Index for Thailand and Vietnam Stock Index for Vietnam.
The use of weekly data prevents some problems associated with daily and monthly
data. Daily data are deemed to have too much noise (Bailey and Stulz, 1990), while
monthly data are affected by the month of the year effect. The choice of the period is
appropriate, as it corresponds to the period when ASEAN?3 initiatives started to
emerge. Table III below presents the descriptive statistics of data used in this research.
The last column of Table III shows the results of Jarque-Bera test for each equity index,
which confrm the non-normality of all equity indices in East and Southeast Asia.
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Long-run cointegration is tested through Johansen (1988) cointegration procedure,
which allows the determination of long-term relationship among non-stationary
variables, despite the possibility that variables being tested are moving in the opposite
direction in the short-run. The Johansen cointegration procedure requires the dataset to
be stationary at frst-differenced form, which is tested using Augmented Dicky–Fuller
(ADF) test. The results of ADF test are shown in Table IV below.
ADF test results confrmthat all equity market indices are non-stationary in the level
but stationary in the frst-differenced form. The next step is to implement Johansen
(1988) procedure, which based on vector autoregressive (VAR) framework. The
Johansen cointegration can be written in an error-correction form, as in equation (1)
below:
?Xt ? ?
0
? ?
1
?X
t?1
? ?
2
?X
t?2
? ?
k?1
? · · · ? ?X
t?k?1
? ?X
t?1
? ?t (1)
Table III.
Descriptive statistics
Market Mean SD Minimum Maximum Skewness Jarque-Bera
Hong Kong 18,640.96 4,346.45 9,636.81 30,468.34 ?0.04 14.01**
Japan 11,815.17 2,846.32 7,173.00 18,239.00 0.72 55.93**
Shanghai 2,382.19 1,007.69 1,013.64 5,903.26 1.14 159.27**
South Korea 1,495.55 425.76 677.28 2,197.82 ?0.35 39.30**
Indonesia 2,312.89 1,263.24 504.09 5,155.09 0.40 38.59**
Malaysia 1,195.67 298.49 691.45 1,775.59 0.14 42.66**
Philippines 3,133.29 1,391.22 1,192.83 7,279.87 0.87 66.24**
Singapore 2,614.79 572.29 1,458.78 3,814.38 ?0.29 33.35**
Thailand 824.77 258.88 392.87 1,627.96 1.09 118.63**
Vietnam 458.76 225.30 130.90 1,155.68 1.28 188.20**
Note: **Denotes that the null hypothesis of normality is rejected at 1% signifcance level
Table IV.
Augmented Dickey–
Fuller (ADF) test
Market Level ADF-statistic First Difference ADF-statistic
Hong Kong ?2.2366 ?22.5867
Japan ?1.4957 ?22.3973
Shanghai ?1.2956 ?13.6569
South Korea ?1.8461 ?23.1599
Indonesia ?0.0257 ?25.4736
Malaysia ?0.6613 ?22.0432
Philippines 0.3559 ?22.9317
Singapore ?1.9545 ?22.1508
Thailand ?0.3478 ?13.7504
Vietnam ?1.9016 ?12.7533
Notes: The critical values for ADF t-statistics for the null hypothesis of a unit root are ?2.57 at the
10% signifcance level; ?2.87 at the 5% signifcance level and ?3.44 at 1% signifcance level; for the
level series, the null hypothesis of a unit root is not rejected; for the frst difference series, the null
hypothesis of a unit root is rejected
111
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Where ?X
t?1
is the error correction term, where ? ? ? ? ?’; the components of the
matrix ?are the short-termcorrection parameters to the long-run relationships refected
in the matrix ?. Johansen cointegration procedures aimto estimate the ?in unrestricted
VAR model and, therefore, test whether the restriction imposed by the rank of ? (i.e.
co-integrating vectors) can be rejected. This study is also interested on the number of
cointegrating equations (k). The cointegration is considered to achieve completion if
number of variables
, or number of equity markets included in the estimation, minusthe number of cointegrating equation (n-k) is equal to one (Click and Plummer, 2005).
Johansen (1988) procedure is chosen over Engle and Granger (1987) to test for
cointegration for several reasons. First, Engle and Granger (1987) rely on the presumed
causal relationship between independent and dependent variable. In this case, Engle
and Granger (1987) may suffer from simultaneous equation bias, as it may fail to
recognize causal direction among equity markets in Asia. Second, Engle and Granger
(1987) are unable to detect more than one cointegrating equation in the case of
multivariate cointegration and this cause inability to verify whether or not the
integration process in ASEAN?3 has achieved perfect completion. On the other hand,
Johansen (1988) can detect more than one cointegrating equation for multivariate setting
and, therefore, is more appropriate to answer the frst objective of this study.
The second objective of this study is to fnd the short-run causality direction between
East and Southeast Asian equity markets. Therefore, the result of cointegration test is
followed by Granger causality test. Granger (1969) causality test examined which
variable moves frst followed by other variable. For the purpose of this research,
Granger causality test provides the short-run causal direction among equity markets in
the ASEAN?3 region. If there is signifcant evidence that equity market X
Granger-causes equity market Y, that can be interpreted that shock in X is followed by
shock in Y. If the results show that equity market X Granger-causes Y and Y also
Granger-causes X, then X and Y are said to have bidirectional short-run linkage. Click
and Plummer (2005) suggest the importance of lag chosen in Granger causality, and this
study chooses eight weeks as the maximum lag length for Granger causality test.
The third objective is to determine the most infuential equity market in East Asia
toward their counterparts in Southeast Asia, and vice versa. This question can be
answered by carrying out forecast variance decomposition, which offers the explanation
of VAR systemdynamics. Forecast variance decomposition examines the proportion of
the changes in a particular equity market, arising out of random shocks, that can be
attributed to random shocks coming from other markets in the ASEAN?3 region.
Variance decomposition determines how much the forecast error variance of a given
variable is explained by the change of explanatory variables. There are two results
presented in this analysis. First, forecast variance decomposition of random shocks on
Southeast Asian equity market due to shocks coming from East Asian market. Second
are the results of forecast variance decomposition performed to each East Asian equity
market with the purpose to observe the contribution of each Southeast Asian market to
the random shock in East Asian equity markets.
4. Results and discussion
This section discusses the results of Johansen cointegration tests to check for long-run
equity market linkage, Granger causality test to check for short-run causality direction
and forecast variance decomposition for each market in East and Southeast Asia.
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Table V presents the results of multilateral Johansen cointegration test for equity
markets in East and Southeast Asia. The cointegration analyses are divided into four
segments, cointegration within sub-regions (cointegration among East Asian and
cointegration among Southeast Asian equity markets), cointegration between East
Asian bloc and individual market from Southeast Asia, cointegration between
Southeast Asian bloc and individual market from East Asia and cointegration between
East and Southeast Asia equity markets.
Second column in Table Vdisplays the results of Johansen cointegration test for East
Asian bloc, while the second column displays the results for Southeast Asian bloc.
Lastly, fourth column shows the cointegration test for all East and Southeast Asian
equity markets. Panle Aof Table Vdisplays the results where the alternative hypothesis
posits one cointegrating vectors, while second panel of Table V show the results with
Table V.
Multilateral co-
integration results
based on Johansen
criteria
Variable
Coverage
East Asia Southeast Asia East and Southeast Asia
Panel A. H0: r ? 0; Ha: r ? 1
Optimal lag 2 1 1
Trace statistic 52.438* 101.641* 272.126*
Cointegrating vectors
Japan 1.000 1.000
Hong Kong ?6.279** (1.171) 0.776** (0.228)
Shanghai 14.116** (2.772) 0.004 (0.560)
South Korea 34.307** (8.856) 0.076 (2.319)
Indonesia 1.000 ?7.285** (1.716)
Malaysia ?3.631** (0.393) 44.524** (5.222)
Philippines ?0.445** (0.096) 3.003** (1.139)
Singapore ?0.236 (0.173) ?9.868** (2.254)
Thailand 1.651** (0.364) ?17.039** (3.305)
Vietnam 1.642** (0.273) ?18.135** (3.150)
Panel B. H0: r ? 1; Ha: r ? 2
Optimal lag 2 1 1
Trace statistic 22.486 55.979 203.578*
Cointegrating vectors N/A N/A
Japan 0.000
Hong Kong 1.000
Shanghai ?13.307** (5.597)
South Korea ?131.67** (30.24)
Indonesia 165.72** (21.78)
Malaysia ?332.03** (64.77)
Philippines ?83.709** (14.77)
Singapore 10.697 (22.259)
Thailand 148.42** (43.336)
Vietnam 221.22** (40.34)
Notes: The Johansen (1988) test is used to test multivariate cointegration with critical values of 95%;
the r denotes the maximum number of cointegrating vectors; *denotes signifcance at 5% level;
standard error is in parentheses; **denotes signifcance at 1% level
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alternative hypothesis of more than one cointegrating equations. Optimal lag for
Johansen cointegration test is chosen based on Schwarz information criteria.
The results of the frst column present the cointegration test within East Asian
sub-regions. The results indicate that East Asian equity markets are integrated as
evident by Johansen cointegration test that is signifcant at 95 per cent level. The
cointegrating vector for East Asia, which is normalized around Japan equity market, can
be written as in equation (2) below:
Japan ?6.28 Hongkong ? 14.12 Shanghai ? 34.31 S.Korea (2)
According to the cointegrating vectors in equation (2), only Hong Kong equity market
has positive long-run relationship with Japan, where 1 per cent positive shock in Hong
Kong index results in 6.28 per cent positive shock in Japan stock market index. On the
other hand, Shanghai and South Korea stock markets have negative relationship with
that of Japan, where 1 per cent increase in Shanghai and South Korea stock market can
cause decrease in Japan index by 14 and 34 per cent, respectively. Although the
coeffcient of Shanghai and South Korea equity market does not make sense
economically, but the sign reveals that Shanghai and South Korean react to the shocks
differently from Japan and Hong Kong reactions. Furthermore, The Johansen
cointegration test shows that there is only one cointegrating vectors (k), whereas there
are four equity markets in East Asia
, resulting in n-k is equal to three. This meansthat the integration process in East Asian is not complete, but there remains the
opportunity for fnancial integration within this sub-region.
The second column presents the result of cointegration test for Southeast Asian bloc.
There exists one long-run cointegration relationship among Southeast Asian equity
markets at 95 per cent level of signifcance. The cointegrating vector for Southeast Asia,
which is normalized around Indonesian equity market, can be written as follows:
Indonesia ? 3.63 Malaysia ? 0.45 Philippines ? 0.24 Singapore ? 1.65 Thailand
?1.62 Vietnam
(3)
The cointegrating vector in equation (3) implies that Malaysia, Philippines and
Singapore have positive long-run relationship with Indonesia equity market,
specifcally 1 per cent increase in Malaysia, Philippines and Singapore stock index
results in 3.63, 0.45 and 0.24 per cent increase in Indonesia stock market index,
respectively. On the other hand, 1 per cent increase in Thailand and Vietnam stock
index are associated with 1.65 and 1.62 per cent decrease in Indonesia stock index,
respectively. These results imply that Indonesia, Malaysia, Philippines and Singapore
respond similarly to external shocks, while Thailand and Vietnam respond differently.
This conclusion does not support the fnding of Click and Plummer (2005) who found
that Indonesia does not have positive long-run relationship with Malaysia and the
Philippines. The similarity of economic development level and relatively closer
geographical distance are among the reason of why Indonesia, Malaysia, the Philippines
and Singapore are expected to have uniform respond to policy shock. Furthermore, the
Johansen cointegration results again show that integration process in Southeast Asia is
far from complete, as evident by only one cointegrating vector.
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The last column of Table V presents the Johansen cointegration test for East and
Southeast Asian equity markets altogether. According to trace statistic, there exist two
cointegrating equations at 95 per cent level of signifcance among equity markets in
East and Southeast Asia. Again, the cointegration test confrms that the integration
process is not complete, as n-k is more than one. The frst cointegrating equation is
normalized around Japan and can be written as:
Japan ? ?0.77 Hongkong ? 0.004 Shanghai ? 0.08 S.Korea ? 7.29 Indonesia
?44.52 Malaysia ? 3.00 Philippines ? 9.89 Singapore ? 17.04 Thailand
?18.14 Vietnam
(4)
Equation (4) shows that Japan stock market has positive relationship with Indonesia,
Singapore, Thailand and Vietnam, and negative long-run relationship with Hong Kong,
Shanghai, South Korea, Malaysia and the Philippines. According to the result, 1 per cent
increase in Hong Kong, Shanghai, South Korea, Malaysia and the Philippines results in
decrease of Japan stock index by 0.77 per cent, 0.004, 0.08, 44.52 and 3 per cent,
respectively. Except for Malaysia, the coeffcient is economically signifcant. On the
other hand, 1 per cent increase in Indonesia, Singapore, Thailand and Vitenam result in
increase of Japan stock market index by 7.29, 9.89, 17.04 and 18.14 per cent, respectively.
From the perspective of regional policy initiation, these results may indicate that East
and Southeast Asian equity markets may respond differently to regional policy shocks,
where the reaction Japan, Indonesia, Singapore, Thailand and Vietnammay be different
from the reaction of Hong Kong, Shanghai, South Korea, Malaysia and the Philippines.
Unequal responses to external shocks or to policy initiatives may hinder the policy
effectiveness of regional authorities and at the same time increase the dependence over
domestic authority. Therefore, policymakers in East and Southeast Asian countries
need to harmonize their capital market regulations following ASEAN?3 capital market
development frameworks to ensure uniform responses to policy incentives.
The second question posed by this study is the short-run causality directions
between East and Southeast Asian equity markets. In this sub-section, the Granger
causality test performed by pairing individual market in East Asia and individual
market in Southeast Asia. Table VI below presents the results of Granger causality
tests.
The frst column shows any possible combination when pairing individual market in
East Asia and individual market in Southeast Asia. The second column presents the
F-test for frst market Granger-causes the second market in each pair. The third column
presents the F-test for second market Granger-causes the frst market in each pair.
According to Table VI, Hong Kong is having bidirectional relationship with
Indonesia, the Philippines and Singapore. Hong Kong also has unidirectional causal
relationship with Malaysia and Vietnam, with the results suggesting that Malaysia and
Vietnamequity markets Granger-cause the Hong Kong equity market, but not the other
way around. Moreover, Hong Kong equity market has no causal relation with Thailand
equity market.
Japan equity market, according to results presented in Table VI, is having
bidirectional relationship with Malaysia, Singapore and Vietnam equity markets.
Furthermore, the results suggest that Japan equity market is having unidirectional
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causal relationship Indonesia, the Philippines and Thailand, with the causal directions
goes from Japan to those Southeast Asian markets. These results indicate that Japan
equity market Granger-causes all equity markets in Southeast Asia but is Granger-
caused by Malaysia, Singapore and Vietnam equity markets only.
Shanghai equity market is found to have bidirectional relationship with Malaysia,
Singapore and Vietnam. Shanghai equity market is also found to Granger-cause the
movement in the Philippines equity market, but has no short-run causal relationship
with Indonesia and Thailand. Table VI also suggests that South Korean equity market
has bidirectional causal relation with Singapore and Vietnam. However, South Korea
equity market has no relationship with equity markets in Indonesia, Malaysia, the
Philippines and Thailand. These results reveal that compared to other East Asian
equity markets, South Korea is the least connected toward Southeast Asian equity
markets.
Altogether, the results indicate that Japan equity market movement Granger-causes
all equity markets movement in Southeast Asia, while Singapore and Vietnam
Granger-cause all equity markets movement in East Asia. This implies that Japan is the
East Asian market with most linkages to Southeast Asian equity markets, while
Singapore and Vietnamare the most connected equity market in Southeast Asia toward
Table VI.
Granger causality
test
Market pairs F-test (1) F-test (2)
Hong Kong, Indonesia 1.945** 1.643**
Hong Kong, Malaysia 1.141 1.693**
Hong Kong, the Philippines 1.550* 1.539*
Hong Kong, Singapore 1.514* 1.975**
Hong Kong, Thailand 1.034 1.355
Hong Kong, Vietnam 1.384 2.572**
Japan, Indonesia 2.294** 0.979
Japan, Malaysia 1.676** 1.658**
Japan, the Philippines 2.248** 0.853
Japan, Singapore 3.342** 1.435*
Japan, Thailand 1.885** 1.301
Japan, Vietnam 1.735** 2.316**
Shanghai, Indonesia 1.372 1.257
Shanghai, Malaysia 1.691** 1.590**
Shanghai, the Philippines 2.003** 1.268
Shanghai, Singapore 2.249** 1.931**
Shanghai, Thailand 1.163 0.965
Shanghai, Vietnam 1.947** 2.612**
South Korea, Indonesia 1.258 1.278
South Korea, Malaysia 0.874 1.339
South Korea, the Philippines 1.192 1.196
South Korea, Singapore 1.575** 1.483*
South Korea, Thailand 0.821 1.152
South Korea, Vietnam 1.535* 2.501**
Notes: F-test (1) denotes the Granger causality test for the frst market Granger-causes the second
market; F-test (2) denotes the Granger causality test for the second market Granger-causes the frst
market; **and *denote the signifcance at 1 and 5%, respectively
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their counterparts in East Asia. However, the Granger causality test provides evidence
that not all of equity markets in East and Southeast Asia are connected both on
bidirectional or unidirectional basis. South Korea, for example, has very limited
short-run linkage with Southeast Asian equity markets, which may cause unequal
short-run responses to region-wide policy initiatives. The results of Granger causality
test again indicate that integration process in East and Southeast Asian region is far
from complete. The government of each country may need to take steps to reduce the
barrier for international capital mobility and, therefore, boost the regional fnancial
integration.
The last analysis is the results of forecast variance decomposition method. If the last
sub-section suggests that Japan equity market is having most linkages toward
counterparts in Southeast Asia, is Japan also the most infuential East Asian equity
market? The last sub-section intends to answer this type of question. The analyses in
this sub-section are divided into two parts. The frst part is the decomposition of random
shocks in each Southeast Asian equity market, while the second is the random shocks
decomposition for each East Asian equity market. The former intends to seek the East
Asia’s most infuential equity market, while the latter intends to search for the most
infuential of Southeast Asian equity markets.
Table VII below exhibits forecast variance decomposition results for Southeast
Asian equity markets. The results show that random shocks in Japan equity market
contribute to 11.67 per cent randomshocks in Indonesia, 5.14 per cent of randomshocks
in Malaysia, 9.73 per cent of randomshocks in the Philippines, 16.65 per cent of random
shocks in Singapore, 9.57 per cent of random shocks in Thailand and 2.66 per cent of
random shocks in Vietnam equity market. For any Southeast Asian equity market, the
random shocks coming from random shocks in Japan far outweigh the random shocks
caused by other three East Asian equity markets. In the case of Indonesia, random
shocks coming fromJapan equity market (11.67 per cent) is even higher than cumulative
random shocks contributed by other Southeast Asian equity markets (10.38 per cent).
These results strongly suggest that Japan is the most infuential East Asian equity
market toward Southeast Asian markets.
However, Table VII also reveals that random shocks in Southeast Asian equity
markets are mainly due to domestic shocks. Indonesia and Vietnam equity markets, for
example, are having more than 70 per cent domestic shocks.
Table VIII presents forecast variance decomposition results for East Asian equity
markets. The results indicate that the portion of random shocks in Hong Kong equity
Table VII.
Forecast variance
decomposition
analyses: percentage
changes in ASEAN
market due to
random shocks in
East Asian markets
(4-week time horizon)
Forecast
variance of
Percentage of forecast variance due to
Hong Kong Japan Shanghai South Korea Other ASEAN Markets Domestic shocks
Indonesia 0.14 11.67 0.08 0.27 10.38 77.46
Malaysia 0.16 5.14 0.30 0.06 32.89 61.45
Philippines 0.44 9.73 0.06 2.88 26.00 58.89
Singapore 0.12 16.65 0.09 0.59 34.08 48.47
Thailand 0.03 9.57 0.15 0.87 41.44 47.94
Vietnam 0.54 2.66 0.41 0.46 15.90 80.03
Note: All numbers are in percentage term
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market due to random shocks in Singapore is 33.49 per cent, far outweigh the random
shocks caused by other East Asian equity markets (14.30 per cent) and domestic shocks
(19.77 per cent). Relative to random shocks caused by other Southeast Asian countries,
shocks caused by Singapore are also dominant in the case of Japan (10.77 per cent),
Shanghai (9.92 per cent) and South Korea (19.77 per cent). Random shocks in Hong
Kong, Japan and Shanghai due to Singapore’s random shocks are even higher than
shocks due to other East Asian markets.
Table VIII also reveals that random shocks in Japan and Shanghai equity
markets are mainly due to domestic shocks, but this is not the case in Hong Kong
and South Korea where external random shocks are more dominant. Overall, the
tests confrm that Singapore is the Southeast Asia’s most infuential equity market
toward East Asia.
General conclusion from forecast variance decomposition analysis is that random
shocks in Southeast Asian equity markets caused by Japan is stronger than random
shocks caused by other Southeast Asian equity markets, whereas Singapore’s infuence
toward East Asian markets is the strongest compared to that of other Southeast Asian
equity markets.
5. Conclusion
This study focuses on equity market integration between East and Southeast Asia,
which helps to understand the possibility of fnancial integration under ASEAN?3
initiatives. Although fnancial integration requires the co-movement of macroeconomic
as well as the inter-linkage of fnancial institutions within the region, but the equity
market integration is defnitely one facet of fnancial integration.
This study fnds evidence of long-run cointegration among East and Southeast
Asian equity markets as well as within each East Asian and Southeast Asian
sub-region. However, the integration process is not complete as evident by the
number of cointegrating vectors. The sign of cointegrating vector also indicates that
reactions of Japan, Hong Kong, Indonesia, Singapore, Thailand and Vietnam to
external shocks may be different from the reactions of Shanghai, South Korea,
Malaysia and the Philippines. The results indicate the urgency of ASEAN?3
member countries to harmonize their capital market regulations and standards to
stimulate the integration process. Furthermore, the harmonization of standards and
regulation encourages the equity markets in East and Southeast Asia to respond
equally to external shocks or policy initiative and, therefore, ensure the full benefts
of regional integration.
Table VIII.
Forecast variance
decomposition
analyses: percentage
changes in East Asia
market due to random
shocks in ASEAN
markets (four-week
time horizon)
Forecast
variance of
Percentage of forecast variance due to
Indonesia Malaysia Philippines Singapore Thailand Vietnam
Other East
Asian markets
Domestic
shocks
Hong Kong 15.07 7.85 8.02 33.49 1.33 0.17 14.30 19.77
Japan 0.48 2.56 2.96 10.77 0.43 0.38 0.78 81.64
Shanghai 5.22 5.17 0.33 9.92 0.12 1.37 0.65 77.22
South Korea 13.95 5.94 6.54 19.77 2.41 0.83 21.32 29.24
Note: All numbers are in percentage term
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It is also observed that Japan is the equity markets in East Asia with most linkages to
Southeast Asia, because the movement of Japan equity index Granger-causes the
movement of all Southeast Asian equity market indices. On the other side, Singapore
and Vietnam are the Southeast Asia’s most connected equity markets toward their
counterparts in East Asia.
This study also confrms that Japan is the East Asia’s most infuential equity
markets in East Asia, as random shocks contributed by Japan equity markets to
Southeast Asian equity markets are higher compared to randomshocks caused by other
East Asian equity markets. For similar reason, Singapore is the most infuential equity
market in Southeast Asia because random shocks in East Asian markets caused by
random shocks in Singapore is higher than random shocks caused by other ASEAN
countries.
Note
1. ASEAN?3 countries consist of ASEANcountries (Brunei Darussalam, Cambodia, Indonesia,
Lao PDR, Indonesia, Malaysia, Myanmar, the Philippines, Singapore, Thailand and Vietnam)
and three East Asian countries (China, Japan and South Korea).
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Corresponding author
Nuruzzaman Arsyad can be contacted at: [email protected]
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