Academic journal article Academy of Accounting and Financial Studies Journal

The Integration of Capital Markets: Correlation Analyses of the Market Indexes in Greater China Economies

Academic journal article Academy of Accounting and Financial Studies Journal

The Integration of Capital Markets: Correlation Analyses of the Market Indexes in Greater China Economies

Article excerpt

ABSTRACT

This paper investigates whether the stock price movements in Shanghai, Hong Kong and Taiwan reflect the increasing economic integration among the three economies. The results indicate that the degree of correlation between the returns of the market indexes in Hong Kong and Taiwan is comparable to that of economic integration between the two economies. But, there is no evidence of similar degree of correlation between the Shanghai market and the Hong Kong and Taiwan markets, despite the increasing economic integration. Further, there is no evidence to suggest that the returns of the Shanghai market have become more integrated with Hong Kong and Taiwan markets over the testing period. The paper provides a possible explanation for the results and discusses several policy implications.

INTRODUCTION

There has been an increasing economic integration in the Greater China region in recent years. China, Hong Kong, and Taiwan are major trading partners and are becoming more economically interdependent. According to China Statistic Yearbook 2000, in 1999, Taiwan's export to Hong Kong was almost $25 billion, significantly more than its export to any other country or region, except for the U.S ($29 billion). At the same time, Hong Kong's import from China reached 606 billion HK dollars in 1999, or 43% of its total import, almost four times as much as its imports from Japan, which was a distant second. Hong Kong's export to China accounted for 30% of its total export, making China its second largest export destination, with the total volume slightly less than that to the U.S. Meanwhile, 47% of the foreign direct investment in China in 1999 came from Hong Kong and Taiwan. According to Wei (1995) between 1984 and 1990, over 50 percent of overseas direct investment in China was from Hong Kong due to linguistic and cultural ties. In 1998, the total overseas direct investment in China amounted to 45. 6 billion U.S. dollars (4.71% of the GDP) of which 69% originated in Asia. Hong Kong and Taiwan remained the two most important sources of direct investment in china. The economic and finance literature (see Agmon (1972), Ibbotson, Carr, and Robinson (1982), and Ripley (1973)) has long documented the existence of significant stock price co-movements among economies with geographical proximity, partnerships in trade, and cultural similarity. The purpose of this paper is to determine whether the stock price movements in the three (Shanghai, Hong Kong, and Taiwan) exchanges exhibit correlation that reflects the increasing trade and investment activities in recent years. The author is not aware of any previous study on these issues and the results should be helpful in assessing the degree of integration among the three economies.

The indexes used in this study are Shanghai Composite, Heng Seng and Taiwan Weighted, from July 1997 to December 2001. Daily, weekly, monthly, and yearly returns of each index are calculated and are used to calculate the correlation coefficients.

The results of the study provide evidence that the degree of correlation between the returns of the market indexes in Hong Kong and Taiwan is comparable to that of economic integration between the two economies. On the other hand, there is no evidence of similar degree of correlation between Shanghai market and the other two markets: Hong Kong and Taiwan, despite the increasing economic integration. Further, there is no evidence to suggest that the returns of the Shanghai market have become more integrated with Hong Kong and Taiwan markets over the testing period. In fact, the test results indicate that the Chinese economy is much more correlated with the Hong Kong and Taiwan economies than the stock market data would suggest. A possible explanation for the low stock market correlation is offered. The findings of this study have significant policy implications.

The rest of the paper is organized as follows. In Section 1, I provide a literature review on market co-movements. …

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