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III. Market Backgrounds
III.1 China
China’s equity market has been in existence since 1990, when both the SSE and the Shenzhen Stock Exchange SHSE were created. China’s equity market is
characterized as less developed compared to Japan and South Korea’s equity markets. Two types of shares are traded in the Chinese stock markets: A shares
for domestic investors and B shares for foreign investors. The stock market experienced its first peak in the early 1990s, led by intense speculative activity,
and returned to more moderate levels in the mid-1990s. Wong 2006 argues that China’s stock market development during this period was driven primarily
by rent-seeking and speculative activities, not by value-driven transactions between investors and fund seekers. Throughout the 1990s, the market was
characterized by frequent price movements see panel ‘a’ of Figure 1. The market experienced an upward trend from the late 1990s to 2000. In 2000,
the market capitalization, the liquidity and the trading volumes doubled from the previous year.
III.2 Japan
Japan’s equity market is the second largest in the world and the largest in Asia Pacific in terms of market capitalization. The history of Japan’s equity trading
dates back to the late 1800s when the TSE and Osaka Stock Exchange were set up. At present, equity trading features in six exchanges in Japan: Tokyo, Osaka,
Nagoya, Fukuoka, Sapporo and JASDAQ. The TSE accounts for approximately 80 percent of market volume and capitalization, followed by the Osaka Stock
Exchange 15 percent and the remaining regional stock exchanges approximately 1 percent each. Japan’s equity market experienced both bubble and burst in the
late 1980s, and, for a brief period from 1989 to 1990, market capitalization exceeded that of the US market.
III. 3 South Korea
South Korea’s equity market has been in existence since 1956, when the country’s first exchange the “Daehan Stock Exchange DSE” was set up. The
DSE was reorganized in 1962 as a joint-stock company. In 1963, the DSE became a non-profit government entity and was renamed the Korea Stock
Exchange KSE also known as the Korea Exchange KE. South Korea’s equity market is substantial in size but is very tightly regulated. Unlike other
Asia-Pacific stock markets, the KSE has managed to sustain steady growth in listings, trading volume and market capitalization.
As demonstrated in Figures 1 through 3, compared to the Japanese and Korean stock markets, the Chinese stock markets have experienced extremely
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large price movements, indicating deviations from the market fundamentals. Such price movement or volatility is attributed to excessive speculation. Wong
2006 argues that the rapid but vulnerable price movementdevelopment in China’s equity market is attributed to three major factors. First, the government
has used the stock market as a vehicle to raise funds for state-owned enter- prises. Second, the repressed financial regime has not allowed free flow of cap-
ital especially capital flight and competition among financial assets e.g. bank deposits, stocks, corporate bonds and government bonds. Third, the legal
framework has been too weak to offer shareholders sufficient protection.
Table 1 shows a correlation matrix as a rough measure of stock price linkages. The matrix shows the correlation between the price and returns
between the three markets. As the correlation matrix demonstrates, the East Asian stock markets react both positively and negatively to the other markets.
Figure 1 Shanghai stock exchange a price and b return indices expressed in logarithms
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The correlation between Japanese stock returns and Korean stock returns is strongly positive, whereas the correlations between Chinese stock returns and
those of the Japanese and Korean stock returns are strongly negative.
IV. Econometric Methodology
