Academic journal article International Journal of Business

Regional Financial Crises and Equity Market Reactions: The Case of East Asia

Academic journal article International Journal of Business

Regional Financial Crises and Equity Market Reactions: The Case of East Asia

Article excerpt


In this paper we investigate the relationship between regional financial turmoil and equity markets of three emerging Asian economies: Indonesia, Malaysia, and Thailand. The study focuses on the contagion of the regional banking and financial difficulties to security markets in these three countries. The VAR and bivariate GARCH model results show that, once the regional financial crisis spreads, equity markets decline and exacerbate the crisis. The speed with which equity markets respond to the regional liquidity and financial turmoil is quite similar despite disparate market capitalization and GDP of the regional economies. The volatility becomes persistent and the equity market and financial sector volatility appear to fuel further volatility in one another. However, we show that Malaysia, the most developed of the sample markets, weathered the crisis quicker and more successfully than the other two. These results have important ramifications for financial market participants, local regulators, and international governing bodies such as the WE

JEL: G14, G15

Keywords: Volatility spillover, Bivariate GARCHModels, Asian Emerging Markets


By the early 1990's, the countries of East Asia were experiencing astonishing widespread economic growth compared with other regions around the globe. Following Japan's lead, the four original "Asian Tiger" countries, Hong Kong, Singapore, Taiwan, and South Korea, were exporting twice as many goods as the whole of Latin America (Tudor, 2000). As the four original Tigers were becoming developed economies, three emerging Southeast Asian economies, Thailand, Indonesia, and Malaysia (dubbed the "new Tigers") also began to experience phenomenal growth and became a focus of international investors. However, by 1997, the economic growth of the new Tigers began to plummet and a full-fledged economic and financial crisis was suddenly at hand. There are many similarities in the ways in which the financial systems of Thailand, Indonesia, and Malaysia reacted during this period.

There have been several theories developed when searching for causes of the Asian financial crisis, although, three major causes are prevalent in these discussions (see Miller and Langaram, 1998, Corsetti et al., 1998). The financial sector of the Asian economies shared the following characteristics. First, there was a heavy reliance on short-term debt, often from foreign lenders. This leaves an emerging market borrower vulnerable to liquidity problems if rates increase dramatically or if capital flows are reversed. (1) Second, holding much of this debt denominated in dollars left the new Tigers susceptible to exchange rate risk when depreciation of the host country currency occurred. Third, inadequate supervision of the banking and financial sectors led to questionable investment choices by financial intermediaries with much of the new infusion of capital. (2) In the extent to which the new Tigers were linked by trade and common credit sources, there is reason to expect that there would be rapid transmission of the economic crisis among Thailand, Indonesia, and Malaysia (Pesenti and Tille, 2000). There is also reason, then, to expect that the crisis in the financial sector would affect individual equity markets of each nation similarly in both speed and manner.

Thailand is a case in point. With the economic slow-down in 1996 and 1997, many questionable investments became unprofitable. When the baht was floated on July 2, 1997, investors lost confidence in the baht and rushed to covert their bahts to dollars. The baht quickly depreciated against the dollar, rendering Thai businesses unable to service their dollar-denominated investments. With banks and financial institutions rushing to reduce their exposure to exchange rate risk, the baht experienced a massive melt down. Financial crisis spread to other sectors of the economy. The loss of investor confidence immediately resulted in the flight of short-term capital out of Thailand and the rest of the Asian economies, which were in a very similar situation. …

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