Academic journal article The International Journal of Business and Finance Research

Influence of External Factors on the Taiwan Stock Exchange

Academic journal article The International Journal of Business and Finance Research

Influence of External Factors on the Taiwan Stock Exchange

Article excerpt

ABSTRACT

Due to the small market size and the low trading volume, emerging markets are, in general, shallow and easily affected by external factors such as the capital flows from foreign portfolio investment and the stock market fluctuations of their major trading partners. This study attempts to investigate how foreign portfolio investment and the trading partner's equity market affect the local stock market and whether such impacts are persistent through time. Adopting the GARCH-EVT-Copula approach, this study takes the Taiwan Stock Exchange as an example to examine (1) the time varying dependencies between the changes in the Taiwan Stock Exchange Capitalization Weighted Stock Index and the changes in foreign portfolio investment volume, and (2) the time varying dependencies between the changes in Taiwan Stock Exchange Capitalization Weighted Stock Index and the changes of the China A-Shares market aggregation index. The empirical results indicated that although foreign portfolio investment started as a strong force in moving the market, it became less influential during the financial crisis period. The stock movements from an emerging market 's top trading partner, however, become more influential as the international trading volume between the two increased and did not weaken even during the financial crisis period.

JEL: G01, G11, G15

KEYWORDS: Foreign Portfolio Investment; GARCH; EVT; Copula

(ProQuest: ... denotes formulae omitted.)

INTRODUCTION

With the shallow market and relatively low trading volumes, stock markets in emerging economies are easily disturbed and manipulated by external factors such as the shifts of foreign portfolio investment flows and the stock market fluctuations from their major trading partners. From emerging markets' point of view, foreign portfolio investment is a doubled-edged sword. On the one side, when foreign capital pours into the emerging stock markets, it provides the capital to support local economic development and, therefore, boosts economic growth. On the other side, since the flow of foreign hot money is unstable in nature, once it flees from the emerging markets, it will tamp down the domestic stock market and cause economic turmoil. As to the dependence between the emerging markets and the markets of their major trading partners, the literature has observed that stock markets tend to integrate with their trading partners. However, the intensity and the persistence of such linkages are not yet well documented, especially during the periods of economic downturns.

To efficiently examine how foreign portfolio investment and the stock market fluctuations of one's top trading partner affect the movements of an emerging stock market, it is important to select a market that is closely monitored by foreign investors and, over time, has attracted a significant amount of foreign investment. This same country has also to be one of those whose economic growth relies heavily on the international trade. To fulfill the criteria above, this study chose the Taiwan Stock Exchange (TWSE) as the sample market for analysis. Taiwan is a country known for its rapid economic growth over the past several decades, and it is the country's international trade that drives such phenomenal growth. During 1990s, Taiwan initiated its stock market openness policy by allowing qualified foreign institutional investors (QFII) to buy shares at the TWSE with strict holding volume restrictions. As the economy grew, Taiwan gradually released its foreign ownership restrictions. On October 2, 2003, Taiwan, finally, fully abolished the restrictions on foreign investors in its stock markets. Around the same time, Taiwan also opened its domestic manufactories to make direct investment in China, establishing that trading partnership. Since then, the TWSE has been affected by both foreign portfolio investment and the Chinese stock markets.

The TWSE is an ideal market that qualifies for this analysis for several reasons. …

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