Asia-Pacific Financial Markets: Integration, Innovation and Challenges: Volume 8

International Finance Review is an annual book series in the international finance area (broadly defined). The IFR, will publish theoretical, empirical, institutional or policy-oriented articles on multinational business finance and strategies, global capital markets and investments, global risk management, global corporate finance and institutions, currency markets and international financial economics, emerging market finance, or related regional or country-specific issues. In general, each volume will have a particular theme. Those interested in contributing an article or editing a volume should contact the Series Editor, J. Jay Choi at E-mail: jjchoi@astro.temple.edu

Perhaps the most significant development in the global business arena in the post-war period has been the emergence of the Asia-Pacific rim countries as a significant economic force.

In this chapter we use a new data weighting process to examine the relationships between stock market returns in major Southeast Asian nations. Investigation is then directed to financial integration between those ASEAN countries and the larger Asia-Pacific region.

The findings indicate that, after the Asian financial crisis, financial integration has continued in most ASEAN countries and between ASEAN countries and the larger Asia-Pacific region. Such effects can be accounted for by the forgetting factor technique. This new technique will provide revenue managers with a decision-making tool to evaluate some complex underlying relationships which managers cannot comprehend prima facie.

This chapter investigates the correlation dynamics in the equity markets of 13 Asia-Pacific countries, Europe and the US using the asymmetric dynamic conditional correlation GARCH model (AG-DCC-GARCH) introduced by Cappiello, Engle, and Sheppard (2006). We find significant variation in correlation between markets through time. Stocks exhibit asymmetries in conditional correlations in addition to conditional volatility. Yet asymmetry is less apparent in less integrated markets. The Asian crisis acts as a structural break, with correlations increasing markedly between crisis countries during this period though the bear market in the early 2000s is a more significant event for correlations with developed markets. Our findings also provide further evidence consistent with increasing global market integration. The documented asymmetries and correlation dynamics have important implications for international portfolio diversification and asset allocation.

This chapter considers the relationship between stock market autocorrelation and (i) the presence of international investors which is proxied by the level of capital market integration and (ii) stock market volatility. Drawing from a sample of nine Asia-Pacific stock indices, significant evidence of a relationship between the presence of international investors and the level of stock market autocorrelation is found. This evidence is consistent with the view that international investors are positive feedback traders. Robustness testing of this model suggests that the trading strategy of international investors changed as a result of the Asian currency crisis. The evidence for the role of volatility in explaining autocorrelation is, however, is generally weak and varies across the sample countries.

The opening up of B-share markets to domestic investors in 2001 is a landmark event in the development of the Chinese stock markets. This chapter aims to assess the possible changes in the market mechanism associated with this important event. A VECM-DCC-MVGARCH model is employed to investigate the market integration process in Chinese stock markets around the opening up of the B-share market to domestic investors. Our empirical results reveal that the Chinese stock markets were segmented before the opening up whereas they were integrated to some extent in the long-run after the opening up of B-share markets. Moreover, it is also found that A-share markets played a dominant role on the information flows between A-share and B-share markets; the short-run information flows between A-share and B-share markets were more rapid after the opening up of B-share markets.

Ng (2002), and Lim and McAleer (2003) explained that if the national economies are not converging, or if the responses of national economies to random shocks are asymmetric, the cost of premature monetary integration would be high. This chapter investigates the feasibility of adopting a single currency for ASEAN-5 countries. The research uses the Kalman Filter procedure to test the economic convergence among ASEAN-5 countries, relative to Japan and the US. In addition, the symmetry of underlying structural shocks is also examined by applying a structural vector autoregression (SVAR) model. The research findings showed that Singapore, Malaysia, and Thailand (ASEAN-3) appear to be relatively suitable for forming an Optimum Currency Area. However, the results did not show significance evidence whether the Japanese Yen or the US dollar will be a suitable currency for the ASEAN-3 countries to adopt commonly.

This chapter investigates empirically the existence of periodically collapsing bubbles in the Asian emerging stock markets using the Enders–Siklos (2001) momentum threshold autoregressive model. As explained in Bohl (2003), this non-linear time series technique can be used to analyze bubble driven run-ups in stock prices followed by a crash in a non-cointegration framework with asymmetric adjustment. This technique offers a more potent insight in the stock prices behavior than can possibly be obtained using conventional non-cointegration tests. The empirical findings for 10 Asian emerging stock markets from 1993 to 2005 refute the bubble hypothesis.

Indicators of financial crises generally do not have a good track record. This chapter presents an early warning system (EWS) for six countries in Asia in which indicators do work. We extract a full list of currency crisis indicators from the literature, apply factor analysis to combine the indicators, and use these factors as explanatory variables in logit models which are estimated for the period 1970:01–2001:12. The quality of the EWS is assessed both in-sample and out-of-sample. We find that money growth (M1 and M2), national savings, and import growth correlate with currency crises.

We tested for evidence of stock price bubbles in the Malaysian stock market from 1978 to 2004. Four different tests were used namely excess volatility tests, unit root/co-integration tests, duration dependence tests, and the intrinsic bubbles model. All four tests indicate that during the sample period, there was evidence of stock price bubbles. All tests results conform to the theoretical literature on asset price bubbles except for the results on the intrinsic bubbles model, which concludes that Malaysian investors under react to information on dividends. We find this result hardly surprising as anecdotal evidence does indicate that Malaysian investors place more importance on capital gains as compared to dividends. Although we do not go into a debate on whether authorities should be prick the bubble to stem its negative effects, we argue that transparent information dissemination will ensure that the stock market becomes more efficient in pricing stocks.

This chapter aims to expand the overreaction literature by examining whether the price reversals occur in the short-term period (i.e., 3 days) and long-term period (i.e., up to 20 days), following large 1-day price changes in Asia-Pacific markets over the period 2001–2005. Our results based on firm data in three Asia-Pacific markets, namely, Australia, Japan, and Vietnam, and static and dynamic measures of large price changes indicate the followings. First, stock prices tend to reverse over the short-term period after large price changes. Second, in the case of large price declines defined by arbitrary trigger values, investors may earn profit from exploiting the phenomena of price reversals; however, the profit is not large enough to exploit since it is less than the profit from passive funds. This result is supportive of the weak form of efficient market hypothesis. Third, we find mixed evidence of long run price reversal across markets. Forth, market conditions (i.e., bear or bull) may not explain the magnitude of price reversals. Finally, the dynamic measures of large price changes based on individual firms provide more consistent evidence across markets, which is supportive of short-term price reversals and overreaction hypothesis. This evidence exists in the emerging market of Vietnam as well as developed Australian and Japanese markets.

Several Asia-Pacific financial markets impose price limits to reduce excessive fluctuations. We examine stock price behavior following daily limit moves on the Shanghai Stock Exchange for 200 firms in the period 1997–2004. We find weak evidence for the occurrence of overreaction on the Shanghai stock market on the basis of price limits. We conclude that investors do not exhibit overreaction to the event of limit activation except in the case of 1-day up limit moves. We also conclude that the Shanghai Stock Exchange can be regarded as a (semistrong) efficient market.

Important developments of China's securities markets within the last two years, namely, the Share Reform, the warrant market, the innovative listed open-end funds (and exchange-traded funds), corporate bonds with detachable warrants, exchange-traded asset-backed securities, are described. The discussion focuses on unique, innovative features of these products, as compared to their counterparts available in more mature markets (when applicable), and points to possible future research themes. The proposed rules with regard to stock index futures and credit trading are also discussed.

This chapter investigates the impact change of the composition of market agents on the timing of the arrival of information in Bursa Malaysia. The price discovery role of futures trading on the spot market is examined through three distinct sub-periods: pre-crisis, crisis and after capital controls. For this purpose, the Johansen Cointegration (1988, 1991) and VECM and Granger causality are used. The analysis shows that there is no significant long-run relationship. As for short-run, the results show futures lead spot. However, futures’ lead is shorter in pre-crisis and crisis periods where foreign institutional investors dominate. This study deduces that the significant change in the composition of market agents could contribute to the variation of lead–lag relationship.

This chapter examines the price impact of large trades in futures markets across 14 stock index futures contracts in 11 different international markets. On the balance, we find that part of the initial price effect of futures trades is temporary. These initial price effects are partially reversed, implying that they incur a liquidity premium; though there is some variation in this finding across markets. We also find strong evidence that large buyer- and seller-initiated trades have positive and negative permanent effects on prices, implying they convey information. We conclude, similar to research based on equities markets, that traders in futures markets are informed.

This study examines financing decisions by Vietnamese firms and compares the results with the findings observed in economies characterized by market mechanisms and property rights. It uses data from Vietnamese enterprises census 2002–2003. Similar to findings in other countries, financial leverage of Vietnamese firms increases with firm size and managerial ownership and decreases with profitability, and with non-debt tax shield. It is also correlated with industry characteristics. Financial leverage was negatively correlated with fixed assets and positively correlated with growth opportunities, contrary to the findings in other countries. Corporate income tax has a negative, albeit small effect on financial leverage.

Based on the event study methodology this chapter tests value creation, buying growth, and hubris hypotheses on the sample of 62 Japanese mergers with announcement in period 1993–2005. We find an average 1.19% cumulative abnormal return in 3 days surrounding the merger announcement. The findings suggest that differences in financial resources allocation pattern may provide a source of value gain. Further, mergers with fast-growing target are value enhancing when acquirer has prior ownership in target. Announcement returns are adversely related to acquirer's past performance, implying that well-performing acquirers possibly overestimate the true value of deal and overpay target.

There are few studies of take over effects in emerging stock markets and of whether such events result in value-increasing or value-decreasing effects for the successful targets and bidders. This study analyses the impact of successful takeovers on the Stock Exchange of Thailand (SET). Both target and bidding firms’ performances during a period of 12 months before and after the takeover are investigated. Abnormal returns are measured using an event study approach; applying two models and three parametric test statistics. The results suggest that Thai takeover effects are wealth-creating for both offeree and offeror shareholders.

We develop our theoretical framework from the viewpoint of the information asymmetry and the agency theory that the Chinese mutual funds exhibit herd behaviour, and provide empirical evidence by using cross-sectional data of all the Chinese mutual funds between 1999 and 2003. We find that the Chinese mutual funds show overall herding, buy herding and sell herding, and the degree of sell herding is higher than that of buy herding. The degree of Chinese herding is higher than their US counterpart from all the three perspectives. This may be largely due to the institutional factors rather than those firm-specific factors that influence the US mutual funds investment decision.

This chapter examines the performance persistence evidences of pension fund managers who managed the constituent equity funds included in Hong Kong Mandatory Provident Fund (MPF) schemes over the period 2001–2004. Nonparametric two-way contingency table and parametric OLS regression analysis are employed to evaluate performance persistence. The evidence suggests that the raw returns, traditional Jensen alphas, and conditional Jensen alphas in the previous year possess predictive abilities. When the funds are classified into high-volatile and low-volatile samples, the high-volatile funds are found to possess stronger performance persistence. Neither hot-hand nor cold-hand phenomena are found in the equity funds managed by same investment manager.

India's planned pension reform will open the sector to private fund managers. Drawing on international experiences, the chapter highlights pre-conditions for the reform to kick-start financial development, including (i) the buildup of critical mass, (ii) sufficiently flexible investment guidelines and regulations, and (iii) concurrent reforms in capital markets. Given the limited scale of the planned reform, the key challenge for India is to achieve sufficient critical mass. Options include granting permission for existing workers to switch to the new system or outsourcing all or part of the reserves of private sector provident funds to the new pension fund managers.

China's accession to World Trade Organization (WTO) opened its financial markets to foreign banks in December 2006. In addition to foreign banks’ expertise and experience in modern banking activities, they also appear to have the interest, competitiveness, and regulatory advantages of competing with Chinese banks in the traditional Renminbi (RMB) business. Such competition will lead to a loss of RMB deposits and loans from local banks. Given that Chinese banks are currently ridden with large non-performing loans and low capital adequacy, the foreign bank entry will exert further pressure on the banks’ profitability and solvency. Without larger regular bailouts from the central government and fundamental changes on the roles of Chinese banks, China may experience a banking crisis in the post-WTO era. We propose two types of policy changes that may improve banks’ competitiveness and reduce the likelihood of a banking crisis.

Certificates of deposit (CDs) are uninsured deposits that have not been protected by the Japan Deposit Insurance Corporation (DIC) since the beginning of the issuance in May 1979. Thus, CDs should reflect exceedingly well banks’ failure probabilities and the risk perception of market participants among many types of depositors in Japan. Because of this, CDs issued by Japanese banks may enhance the market discipline of banking organizations. This is the first chapter to test the depositor discipline hypothesis using Japanese bank data from the financial year 1998 to the financial year 2003 . The chapter develops reduced-form models that describe how interest rates and the quantity of CDs may be related to banks’ financial measures. Among the Japanese CAMEL ratings, the chapter finds that CD interest rates are sensitive to the capital adequacy ratio (CAR) and that CD quantities are sensitive to ROA. The chapter also insists that CD holders in Japan are sensitive to bank risks and exercise disciplinary power to impose market discipline that compliments regulatory discipline.

Recently East Asian policymakers have focused on facilitating corporate bond market development through a host of financial market reforms including greater foreign participation in the domestic markets as issuers and investors. However, the alternate approach – the encouragement of domestic issuers to further tap international markets – remains largely ignored. The objective of this study is to investigate these issues in the context of reform undertaken by Thailand following the Asian Crisis of 1997. As a small and open economy, Thailand was forced to become more receptive to foreign investment and capital market participation. We raise the significance of bond return volatility and skewness as an impediment to greater involvement by international investors. Empirical analysis highlights the time-varying nature of both variance and skewness of bond returns, which can only be overcome through government policy that focuses upon stabilizing the macroeconomic environment and not simply enhancing domestic and regional financial market infrastructure.