Are ASEAN Stock Markets Interdependent?

1. Are ASEAN Stock Markets Interdependent? ECON 7710 CHE Yuen Shan GUERRA Archimedes David

2. Evidence #1

3. Evidence # 2

4. Evidence #3

5. Why is it important to know if stock markets are interdependent? • Serve as the basis for global diversification strategy • Help guide regional financial policy formulation • Reflect regional economic couplings or linkages

6. Spurious Regression

7. Spurious Regression • Cointegration tests aim to avoid “spurious regressions”, and show valid long term equilibrium relationships (Granger 1986)

8. The Data • Adjusted weekly closing prices of five ASEAN stock market indices: • Indonesia – Jakarta Composite Index (JCI) • Malaysia – Kuala Lumpur Composite Index (KLCI) • Philippines – Philippine Stock Exchange Index (PSEI) • Singapore – Straits Times Index (STI) • Thailand – Stock Exchange of Thailand Index (SET) • Advantages of weekly data • Daily data contain “too much noise” (Bailey and Stulz,1990) • Monthly data highly seasonal (Roca et al., 1998)

9. The Data • Period of study: January 3, 2000 to November 8, 2010 (567 weeks) • After 1997 Asian financial crisis • Covers widespread use of Internet and other advances in communications technology • Includes period from 2008 subprime crisis to today • The indices are in domestic currency to avoid problems from transforming the indices into one currency due to the cross-country exchange rate (Subramanian 2008)

10. The Data • Descriptive Statistics: • Weekly Closing Prices

11. The Data • Descriptive Statistics: • Weekly Closing Prices in Natural Log

12. Methodology • Unit Root Test • To find out if the time series are nonstationary , and are integrated of the same order, I(d) • An I(d) time series has to be differenced d times before it becomes stationary • Cointegration Test • To test the presence of long-run equilibrium relationships among nonstationary time series, or if these share similar stochastic trends • Granger Causality Test • To test possible short-term price linkages among the ASEAN markets (Roca et al. ,1998)

13. Unit Root Test • Augmented Dickey-Fuller (ADF) Test • Extends the standard Dickey-Fuller test to cover higher-order autoregressive processes, AR(p) • Tests the following hypotheses using the t-ratio • H0 :  = 0 • H1 :  < 0 where  =  - 1

14. Unit Root Test • Phillips-Perron (PP) Test • Modifies the t-ratio of the  coefficient so that serial correlation does not affect the asymptotic distribution of the test statistic

15. Unit Root Test Results • All market index series are nonstationary • All market index series are integrated of order one, or I(1) • The set of series are fit for cointegration testing

16. Cointegration Test • Johansen Cointegration Test (1995) • Given a VAR of order p where yt is a k-vector of nonstationary I(1) variables, xt is a d-vector of deterministic variables, and t is a vector of innovations. This VAR may be rewritten as where

17. Cointegration Test • Assumptions • The level data yt have no deterministic trends and the cointegrating equations have intercepts: • Lag Interval: 1 1

18. Cointegration Test Results

19. Cointegration Test Results

20. Granger Causality Test • The following error correction models are tested: • Unrestricted models: • Restricted models: • The null hypothesis is all the s of the unrestricted model equals zero. If the null hypothesis is rejected, then the series are Granger causes to each other.

21. Granger Causality Test Results

22. Granger Causality Test Results • The ASEAN market indices, except the PSEi, are not significantly affected by their own previous prices • KCLI has a two-way linkage with all other markets. PSEi has a unidirectional causality with all the indices except KCLI • Both STI and SET can only be explained by the past price of KLCI significantly and are insignificantly explains be the other ASEAN market indices

23. References • Abhyankar, A., “Linear and nonlinear Granger causality: Evidence from the U.K. stock index futures market.” Journal of Futures Markets 18 (1998), 519-540. • Bailey, W. and Stulz, R., “Benefits of International Diversification: The Case of the Pacific Basin Stock Markets.” Journal of Portfolio Management (Summer 1990), 57-61 • EViews 6 User’s Guide II. Quantitative Micro Software, LLC (2007). • Granger, C.W.J, “Causality, cointegration, and control.” Journal of Economic Dynamics and Control 12 (1988), 551-559. • Granger, C.W.J, “Developments in the Study of Co-integrated Economic Variables.” Oxford Bulletin of Economics and Statistics 48 (1986), 226 • Granger, C.W.J, “Investigating Causal Relationships by Econometric Models and Cross Spectral Models.” Econometrica 37 (1969), 424-438.

24. References • Helmut, L., Hans-Eggert, R., “Granger-causality in cointegrated VAR processes: The case of the term structure.” Economics Letters 3 (1992), 263-268. • Johansen, S., Likelihood-based Inference in Cointegrated Vector Autoregressive Models. Oxford: Oxford University Press (1995). • Roca, E. D., Selvanathan, E. A., Shepherd, W. F., “Are the ASEAN Equity Markets Interdependent?” ASEAN Economic Bulletin 15 (1998), 109-120. • Subramanian, U., “Cointegration of Stock Markets in East Asia.” European Journal of Economics, Finance and Administrative Sciences 14 (2008). • http://support.sas.com/rnd/app/examples/ets/tourism/index.htm • http://support.sas.com/documentation/cdl/en/etsug/60372/HTML/default/etsug_varmax_sect049.htm • http://support.sas.com/rnd/app/examples/ets/granger/index.htm