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
Cointegration tests aim to avoid spurious regressions, and show valid long term equilibrium relationships (Granger 1986)
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)
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)
The Data Descriptive Statistics: Weekly Closing Prices
The Data Descriptive Statistics: Weekly Closing Prices in Natural Log
Methodology 1. 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 2. Cointegration Test To test the presence of long-run equilibrium relationships among nonstationary time series, or if these share similar stochastic trends 3. Granger Causality Test To test possible short-term price linkages among the ASEAN markets (Roca et al.,1998)
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 H 0 : = 0 H 1 : < 0 where = - 1
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
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
Cointegration Test Johansen Cointegration Test (1995) Given a VAR of order p where y t is a k-vector of nonstationary I(1) variables, x t is a d- vector of deterministic variables, and t is a vector of innovations. This VAR may be rewritten as where
Cointegration Test Assumptions The level data y t have no deterministic trends and the cointegrating equations have intercepts: Lag Interval: 1 1
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.
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
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 Users 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.
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_var max_sect049.htm http://support.sas.com/documentation/cdl/en/etsug/60372/HTML/default/etsug_var max_sect049.htm http://support.sas.com/rnd/app/examples/ets/granger/index.htm