Academic journal article Journal of Economics and Finance

Spillover Effects on the Sectoral Returns for Australian and New Zealand Equity Markets

Academic journal article Journal of Economics and Finance

Spillover Effects on the Sectoral Returns for Australian and New Zealand Equity Markets

Article excerpt

(ProQuest: ... denotes formulae omitted.)

1 Introduction

Since equity investment has become one of the dominant investment vehicles, the most efficient way to diversify portfolio risk in the equity market has become one of the major concerns of the financial analysts up to today. Along with the processes of globalization and regionalization, equity markets in many countries have become increasingly integrated. Many of the previous studies have investigated the financial integration of the equity markets. However, among those previous studies, the majority have focused on the integration of the developed markets, such as the US, EMU or Japanese markets. More importantly, despite numerous empirical studies examine, the integration of the equity markets the literature on the integration the equity markets on sectoral basis is scarce.

At the regional level, financial market integration seems to be strengthened mostly via the formation of free-trade areas or currency unions. It has been shown that the formation of currency unions reduces country-specific risk factors, as exchange rate uncertainty is eliminated and the countries that become members of the unions boost investors' confidence (Baele 2005). However, the risk premia differences in equity markets depend on the relative degree of integration of the overall markets. In theory, under perfect financial market integration, the equity risk premium is determined solely by the risk factors common to all countries (global or local), and not by a combination of local and global factors, as is the case under partial integration. Using this theoretical framework, Baele (2005) showed that differences in equity returns in the Euro markets are driven by the magnitude of the reaction of these markets to common shocks. The main interest is the impact of the integration of the equity markets on returns and the volatility spillover effects arising from local and global shocks. Following Bekaert and Harvey (1997), several studies have measured the equity markets integration, and found significant return and volatility spillover effects resulting from local and global shocks. All these studies suggest that the effect of countryspecific factors on the equity returns has declined over time, while the correlation between local and global market returns has increased, substantiating a rise in the degree of national equity markets integration. Although the debate between investors and financial analysts as to whether stock market diversification should be sectoral or national is still ongoing, the literature has little to say when it comes to measuring the integration of equity markets on a sectoral basis.1

Early empirical research on equity market integration has focused on the conditional volatility implied by the ARCH/GARCH models introduced by Engle (1982) and Bollerslev (1986). Subsequently, spillover analysis was developed by Engle et al. (1990). Lin et al. (1994) first used this framework to investigate the volatility spillover effects between the US and the Japanese stock markets. Since then, the integration of the equity markets and the effects of the return and volatility spillovers on markets have been studied intensely. These include the works of Fratzscher (2002), Baele (2005) and Balli and Balli (2011) for the European equity markets; Bekaert and Harvey (1997), and Balli et al. (2013b) for emerging stock markets; Balli et al. (2014) Asian sectoral returns, Kanas (1998) for the three largest European equity markets, i.e. London, Ng (2000) on the volatility spillover effects in various Pacific Basin stock markets. Along the same lines, (Lakshmi and Premaratneb 2004) found evidence of spillover from the smaller markets to dominant markets (from Singapore into Hong Kong, Japan and US markets), Edwards and Susmel (2001) found strong evidence of volatility spillover effects across Latin American countries, especially among the Mercosur countries. Fedorova and Saleem (2009) looked into the linkages between emerging Eastern European equity markets and Russia from the perspective of volatility spillovers and Yilmaz (2010) documented strong return spillover effects in the Eastern Asian markets. …

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