Academic journal article International Journal of Business

An Analysis of the Short- and Long-Run Relationships between South Asian and Developed Equity Markets

Academic journal article International Journal of Business

An Analysis of the Short- and Long-Run Relationships between South Asian and Developed Equity Markets

Article excerpt

ABSTRACT

In this paper, I conduct a detailed, large sample analysis of the short- and long-run relationships between the South Asian markets of India, Pakistan and Sri Lanka and the major developed markets during July 1997--December 2003. Using a multivariate cointegration framework and vector error-correction modeling I find that the Indian market is influenced by the US, UK and Japan and that this influence has persisted following the September 11, 2001 terrorist attacks on the US. For Pakistan and Sri Lanka I find that these markets are relatively isolated from the major developed markets during the entire sample period. I also find that the three South Asian equity markets are becoming more integrated with each other but at a relatively slow pace.

JEL: F30, F36, G15

Keywords: South Asian markets; Emerging markets; Cointegration; Vector error-correction model

I. INTRODUCTION

Previous researchers have examined the short- and long-run relationships among the major developed equity markets and markets in the Asian region for several years. Some researchers, including Eun and Shim (1989), Cheung and Mak (1992), Park and Fatemi (1993), Chung and Liu (1994), Arshanapalli, Doukas and Lang (1995), and Janakiramanan and Lamba (1998), use vector autoregression (VAR) modeling and impulse response analysis to examine these relationships. The main focus of these studies is to examine the short-run causal linkages among equity markets to better understand how shocks in one market are transmitted to other markets. These studies typically find that the US influences most markets in the Asian region, while markets in this region have little influence on the US market. The UK appears to exert some influence on markets in Japan, Australia, and Hong Kong. Previous studies also find that Japan, the second largest equity market, has little influence on other equity markets. In addition, the linkages among Pacific-Basin equity markets can often be attributed to the direct and indirect influences of the US market.

Other studies, including Chan, Gup and Pan (1992, 1997), Kasa (1992), Hung and Cheung (1995), and Masih and Masih (2001), use the cointegration framework to examine the long-run relationships and the level of market integration among markets in the Asian region and between these markets and developed markets. Some researchers, such as Arshanapalli and Doukas (1993), Masih and Masih (1997, 1999) and Sheng and Tu (2000), have specifically focused their attention on the effect of market crashes on the relationships among these markets. (1) These studies generally tend to find a long-run relationship among Asian equity markets and the major developed markets of Japan, US, and UK.

While previous researchers have examined the linkages among various equity markets in the Pacific-Basin region, South Asian markets have received very little interest resulting in few studies that have examined the short- and long-run behavior of these markets in any detail. One exception is Ghosh, Saidi and Johnson (1999) who examine the long-run relationship between the US and Japan and the Indian market during the Asian financial crisis period of 1997. They find a long-run cointegrating relationship between the US and the Indian market but not between Japan and India. However, their conclusions are limited in scope because of the very short time period of 201 trading days examined. In addition, they examine the relationship among these markets in a bivariate, rather than multivariate, setting. (2)

Countries in the South Asian region have experienced considerable political and social turmoil over the past few years. At the same time, these countries have also deregulated their capital markets and removed barriers to international investment. In addition, the Asian financial crisis in 1997 and the substantial market falls following the terrorist attacks on the US on September 11, 2001 may have exerted influence on these markets potentially making them more integrated with major developed markets. …

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