B. Cha, S. Oh International Review of Economics and Finance 9 2000 299–322 301
markets, it would be interesting to analyze how the crisis altered the relations between markets of developed countries and AEMs.
This paper empirically investigates several aspects of the influence of the U.S. Japanese markets on Asian markets. The paper seeks to determine the size of the
impact, the speed of transmission, and which market, the American or Japanese, has the greater influence. Presumably, the influence from the U.S. and Japan would be
different depending on whether an AEM had been a victim of the financial crisis or not. It is likely that the stock market of a crisis country might have become more
sensitive to unexpected movements of the U.S. and the Japanese stock markets than that of a country which had escaped crisis. To test this hypothesis, we compare the
case of Korea, which was hit hard by the financial crisis, with Hong Kong, Singapore, and Taiwan, which successfully averted a crisis.
As mentioned above, the greater a country’s restrictions on international capital flows, the lesser the degree of integration between that country’s stock market and
the world stock markets. A number of Asian countries have put strict restrictions on foreign ownership, which has the effect of blocking foreign direct investment and
other foreign exchange transactions. While Singapore and Hong Kong opened up their stock markets early and have guaranteed almost free capital flows without any
restrictions,
1
Korea and Taiwan have historically imposed many restrictions on foreign ownerships.
2
Since the financial crisis began, Korea has lifted most restrictions on foreign direct investment and foreign ownership, and it will be very interesting to
examine whether such deregulation has caused any change in the channel through which the Korean stock market is influenced by the American and Japanese stock
markets.
3
In investigating the issues mentioned above, this paper uses the vector autoregres- sion VAR method with a proper control for heteroscedasticity. The VAR model is
particularly well suited for our purpose since it avoids the problems inherent in the single-equation method yet still yields useful econometric evidence with which to
examine the relative importance of the two major markets on the AEMs.
The rest of the paper is organized as follows: Sections 2 and 3 describe the data and the methodology employed, respectively. Section 4 presents the empirical results,
and Section 5 concludes the paper.
2. Data
2.1. Data The stock markets analyzed in this paper are those of the four AEMs: the Stock
Exchange of Hong Kong SEHK, the Korean Stock Exchange KSE, the Stock Exchange of Singapore SES and the Taiwanese Stock Exchange TSE. In terms
of market capitalization expressed in U.S. dollars, these are the four largest Asian markets after the Japanese and Australian markets.
The market indices used in the empirical study are as follows: the Hang Seng Index for the SEHK, the Composite Stock Index for the KSE, the Straits Times Index for
302 B. Cha, S. Oh International Review of Economics and Finance 9 2000 299–322
Fig. 1.
Stock price
indices.
B. Cha, S. Oh International Review of Economics and Finance 9 2000 299–322 303
the SES, the Weighted Index for the TSE, the SP 500 Index for the U.S., and the Nikkei 225 Index for Japan. Weekly stock returns are computed as the percentage
log difference of the closing prices on Fridays. Weekly stock returns are used as opposed to daily ones, to avoid the problem of nonsynchronous trading in some thinly
traded stocks.
The study covers the period from January 4, 1980, to September 18, 1998. To examine the stability of the results, the whole sample period is divided into three
subperiods: January 4, 1980–September 25, 1987 Period I, November 6, 1987–June 27, 1997 Period II, and July 4, 1997–September 18, 1998 Period III. The Crash of
October 1987 separates Periods I and II. The period of October 1987 is excluded from the sample. Periods II and III are separated by the start of the Thai collapse
on July 2, 1997, the date the central bank of Thailand changed the Thai exchange rate system from the multicurrency basket system to the managed floating system. In
retrospect, it is clear that this is the event that triggered the devaluations in other Asian countries and eventually caused the Asian foreign exchange and financial crises.
Figs. 1 and 2 show the level of stock price indices and return rates over all three periods.
To test for the stationarity of stock returns, the Dickey-Fuller test DF and the augmented Dickey-Fuller test ADF are used. In these tests, the null hypothesis that
the national stock indices have a unit root is tested against the alternative hypothesis that they do not. The results confirm the presence of a unit root in the levels of all
stock price indices, but there is no evidence of a unit root in their first differences in any of the subperiods or in the whole sample period.
4
2.2. Diagnostic statistics Table 1 shows the mean and the standard deviation of the rate of return for each
market during the sample period. For the whole sample period as well as for each subperiod, all four AEMs have higher levels of risk than either the Japanese or the
U.S. markets. Only Taiwan, however, shows a higher return for the whole sample period; the rates of return in the other three AEMs are all lower than the U.S. market’s
rate of return. In other words, Hong Kong, Singapore, and Korea have the unfavorable combination of higher risks and lower returns than the U.S. market. The reason for
this is that the rates of return of the AEMs began deteriorating after the October Crash of 1987, and have declined particularly sharply since the outbreak of the Asian
financial crises. During Period I, the AEMs performed quite well against the developed markets: Hong Kong, Korea, and Taiwan recorded higher rates of return than either
the U.S. or Japanese markets, while the rates of return in the Singapore market were higher than the U.S. but lower than Japan. The rates of return in the AEMs started
deteriorating only in Period II, when only the Hong Kong market managed to maintain a higher rate of return than the U.S.. The Japanese market also tumbled during
Period II and exhibited a negative rate of return, reflecting the decade-long economic stagnation during this period.
During Period III July 1997–September 1998, the Japanese market showed a record-low performance, and all four AEMs also exhibited negative rates of return.
304 B. Cha, S. Oh International Review of Economics and Finance 9 2000 299–322
Fig. 2.
Stock return
rates .
B. Cha, S. Oh International Review of Economics and Finance 9 2000 299–322 305
Table 1 Mean and standard deviation of weekly return rates unit:
Whole Sample Period: 8014,98918 US
JAPAN HONG KONG
KOREA SINGAPORE
TAIWAN Mean
0.231 0.078
0.222 0.113
0.077 0.258
Standard Deviation 2.013
2.474 4.070
3.343 3.148
4.508 Period I: 8014,87925
US JAPAN
HONG KONG KOREA
SINGAPORE TAIWAN
Mean 0.273
0.333 0.375
0.391 0.288
0.508 Standard Deviation
2.101 1.645
4.180 2.745
2.806 2.888
Period II: 87116,97627 US
JAPAN HONG KONG
KOREA SINGAPORE
TAIWAN Mean
0.250 20.021
0.380 0.075
0.173 0.237
Standard Deviation 1.739
2.790 3.185
2.977 2.316
5.437 Period III: 9774,98918
US JAPAN
HONG KONG KOREA
SINGAPORE TAIWAN
Mean 0.169
20.566 21.093
21.508 21.234
20.441 Standard Deviation
2.326 3.400
5.762 7.140
5.729 3.640
The Korean market in particular recorded the lowest return rate and the highest level of risk among the four AEMs. It is interesting that Taiwan, which has relatively more
restrictions on international capital movements than other countries, both successfully escaped a crisis and also exhibited the lowest level of risk and the smallest fall in
rates of return.
2.3. Contemporaneous correlations Table 2 provides the correlation coefficients among the return rates of six stock
markets for each period separately and the entire sample period together. Although the correlation between the U.S. and Japanese markets actually decreased over the
three periods, almost all the other markets showed increased levels of correlation with each other over time. For example, the correlation coefficients between the rates
of return of Hong Kong and the U.S. are 0.213 in Period I, 0.238 in Period II, and 0.450 in Period III. Between Singapore and the U.S., the correlation coefficient goes
from 0.235, to 0.291, to 0.472 in the three periods, respectively. A similar increasing trend also appears in the relationship between the U.S. and Korea, and between the
U.S. and Taiwan, although Taiwan’s correlation coefficient dropped slightly in Period II. Such increases in the correlation coefficients are particularly distinctive between
the U.S. and all four AEMs in Period III: 0.450 in Hong Kong, 0.274 in Korea, 0.472 in Singapore, and 0.473 in Taiwan.
306 B. Cha, S. Oh International Review of Economics and Finance 9 2000 299–322
Table 2 Contemporaneous correlation coefficients
Whole Sample Period: 8014,98918 US
JAPAN HONG KONG
KOREA SINGAPORE
TAIWAN US
1 0.330
0.243 0.106
0.333 0.112
JAPAN 1
0.218 0.198
0.313 0.210
HONG KONG 1
0.122 0.487
0.150 KOREA
1 0.128
0.049 SINGAPORE
1 0.219
TAIWAN 1
Period I: 8014,87925 US
JAPAN HONG KONG
KOREA SINGAPORE
TAIWAN US
1 0.378
0.213 0.041
0.235 0.072
JAPAN 1
0.231 0.138
0.230 0.098
HONG KONG 1
0.013 0.319
0.095 KOREA
1 0.082
0.025 SINGAPORE
1 0.083
TAIWAN 1
Period II: 87116,97627 US
JAPAN HONG KONG
KOREA SINGAPORE
TAIWAN US
1 0.302
0.238 0.121
0.291 0.036
JAPAN 1
0.193 0.187
0.326 0.218
HONG KONG 1
0.156 0.533
0.111 KOREA
1 0.165
0.039 SINGAPORE
1 0.224
TAIWAN 1
Period III: 9774,98918 US
JAPAN HONG KONG
KOREA SINGAPORE
TAIWAN US
1 0.361
0.450 0.274
0.472 0.473
JAPAN 1
0.273 0.310
0.254 0.297
HONG KONG 1
0.236 0.675
0.399 KOREA
1 0.151
0.472 SINGAPORE
1 0.116
TAIWAN 1
The correlation coefficients between the AEMs and Japan also increased over the sample period. With the exception of Hong Kong in Period II and Singapore in Period
III, all other correlation coefficients between the AEMs’ return rates and Japanese return rates consistently increased over the three periods. In Period III, the coefficients
were 0.273 in Hong Kong, 0.310 in Korea, 0.254 in Singapore, and 0.297 in Taiwan.
The data in Table 2 provides the first evidence of co-movements between the rates of return of the four AEMs with those of the U.S. and Japanese markets. In Korea
B. Cha, S. Oh International Review of Economics and Finance 9 2000 299–322 307
and Taiwan, which have had relatively more restrictions on international capital flows than other AEMs, the return rates exhibited only weak correlation with those in the
U.S. and Japan before the Asian financial crisis. Since the crisis, however, the correla- tion has become much greater.
3. Method
