East Asian Equity Markets, Financial Crisis, and the Japanese Currency
Stephen Yan-leung CheungProfessor of Finance (Chair)Department of Economics and FinanceCity University of Hong Kong
July 24, 2002
East Asian Equity Markets, Financial Crisis and the Japanese Currency
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Agenda
1. Motivations
2. Objectives
3. Data
4. Methodology and Results
5. Conclusions
East Asian Equity Markets, Financial Crisis and the Japanese Currency
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Motivations
a. Yen/ US volatility
• Yen/ US was very volatile during the last
decade
• From 80 Yen/US to 147 Yen/US
• Yen’s depreciation reduce Asia’s trade deficit
with Japan from an annual deficit of $59 billion
in 1995-97 to $ 19 billion in 2001
East Asian Equity Markets, Financial Crisis and the Japanese Currency
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Yen/USD movement during 1990-2002
80
90
100
110
120
130
140
150
1601/
1/90
1/1/
91
1/1/
92
1/1/
93
1/1/
94
1/1/
95
1/1/
96
1/1/
97
1/1/
98
1/1/
99
1/1/
00
1/1/
01
1/1/
02
Source: DataStream
East Asian Equity Markets, Financial Crisis and the Japanese Currency
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Motivations
b. Interest rate differential
• Low interest rate in Japan and Yen’s
depreciation
• Yen carry trade looked lucrative
East Asian Equity Markets, Financial Crisis and the Japanese Currency
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Interest rates in Asian countries
0
5
10
15
20
25
30
Jan-
90Ju
l-90
Jan-
91Ju
l-91
Jan-
92Ju
l-92
Jan-
93Ju
l-93
Jan-
94Ju
l-94
Jan-
95Ju
l-95
Jan-
96Ju
l-96
Jan-
97Ju
l-97
Jan-
98Ju
l-98
Jan-
99Ju
l-99
Jan-
00Ju
l-00
Jan-
01Ju
l-01
Jan-
02
Japan Discount Rate US Federal Funds Rate
HK Interbank Offered Rate: 1 Month SG Interbank Rate: 1 MonthTW Interbank Rate: Overall Weighted Average KW Call Rates: 1 to 15 Days Average
East Asian Equity Markets, Financial Crisis and the Japanese Currency
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Motivationsc. Trade deficit
• Yen’s depreciation has positive effect on Japan’s economy, e.g. reduced Asia’s trade deficit with Japan from an annual deficit of $59 billion in 1995-97 to $19 billion in 2001. (duplicated, pls refer point (a)!!!)
• Had tremendous pressure on Korean and Taiwanese exports
• On 15 June 1998, Yen hit 14 Yen/US• Finance Minister of China expressed that pressure for
a devaluation of the Yuan was growing• There was a fear of another round of competitive
devaluation.• Japan used to be a growth engine, fear on Asian
economies.
East Asian Equity Markets, Financial Crisis and the Japanese Currency
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Asian stock indices and Dollar/Yen exchange rate
0
0.5
1
1.5
2
2.5
01/95 06/95 11/95 04/96 09/96 02/97 07/97 12/97 05/98 10/98 03/99 08/99 01/00 06/00 11/00 04/01 09/01 02/02
Re
lati
ve v
alu
e o
f th
e i
nd
ice
s a
s o
f 01
/95
0
20
40
60
80
100
120
140
160
Ye
n t
o U
SD
HANG SENG INDEX NIKKEI 225 SINGAPORE STRAITS TIMES
KOREA SE COMPOSITE (KOSPI) TAIWAN SE WEIGHTED JAPANESE YEN TO US $
East Asian Equity Markets, Financial Crisis and the Japanese Currency
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Motivations Asian emerging markets, good investment
opportunities before Asian Crisis (Levy and Sarnat, 1970; Solnik, 1974)
US market, the leading market (Cha and Cheung, 1998; Cheung and Ng, 1996)
The Change in information transmission mechanism after crisis (Cha and Cheung, 1998; Tuluca and Zwick, 2001)
East Asian Equity Markets, Financial Crisis and the Japanese Currency
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Objectives 1. Study the information structure changes
between the equity markets in the US and four
East Asian economies during the Asian crisis;
and
2. Examine the impacts of Japanese currency
movements on these four East Asian economies
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DataDaily logarithmic returns: Hong Kong Korea Singapore Taiwan US
Sample period: Pre-crisis period: January 1995 – June 1997 Crisis period: July 1997 – June 2000 Post-crisis period: July 2000 – July 2001
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Methodology and results
Stationarity1. Dickey-Fuller test:
- all stock indices are I(1) processes
2. Johansen cointegration test on the indices of the US and four Asian economies :
- Pre-crisis period: pairwise cointegrated- Crisis and post-crisis period: no cointegration- Action: include an error correction term for the pre-
crisis period only
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Table 1. Unit Root Test Results
Lag ADF Lag ADF Lag ADF Lag ADFHK 7 -3.03 4 -2.94 0 -2.81 4 -2.26SG 1 -2.06 1 -2.15 0 -2.62 1 -1.76TW 0 -1.88 0 -2.39 4 -1.72 4 -0.80KW 1 -2.58 1 -2.27 0 -2.32 1 -1.82
US 0 -2.50 0 -2.74 0 -2.73 0 -1.77
Lag ADF Lag ADF Lag ADF Lag ADFHK 9 -8.87 3 -13.94 4 -7.57 3 -20.40SG 9 -7.92 0 -23.25 0 -17.00 0 -35.57TW 0 -26.52 0 -26.71 3 -9.46 3 -21.82KW 0 -22.46 0 -24.97 1 -12.42 4 -19.97
US 0 -24.77 9 -9.04 1 -12.68 2 -25.50
Panel B: First Difference of the Logarithm Indexes seriesPre-Crisis During Crisis Post Crisis Combined
Panel A: Level of the Logarithm Indexes seriesPre-Crisis During Crisis Post Crisis Combined
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Interaction patternCausality test: - decide the lead-lag relationship between 2 stock indices
Hypothesis 1: The US leads the East Asian Economies?
Xt = C + j=1,…,k jXt-j + j=1,…,n jYt-j + t where
Xt = Return on one of East Asian market indexes at time t, as measured by first log differences
Yt = the return on the US stock index - Causality: using joint significance of j's to test whether the la
gged values of Yt provide additional explanatory power for Xt after controlling for Xt's own history.
East Asian Equity Markets, Financial Crisis and the Japanese Currency
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Interaction pattern
Hypothesis 2: The East Asian Economies lead the US?
Yt = C + j=1,…,k jYt-j + j=0,…,n jXt-j + j=1,…,m jSt-j + t
Note: Second summation index j starts from 0 instead of 1, because
the US and East Asian markets operate in different time zones
GARCH effects: - the error term and lagged dependent variables are not independent- Action:
- maximum likelihood procedure - construct the likelihood ratio statistic to test the hypothesis that js ar
e zero
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Interaction patternResults: The US leads the East Asian Economies?
- Pre-crisis period: only leads Hong Kong and Singapore- Crisis and Post-crisis period: all- Error correction term is significant in all cases
- these East Asian markets do respond to deviations from the cointegrating relationships
The East Asian Economies leads the US?- Pre-crisis period: all except Taiwan- Crisis period: all- Post-crisis period: NO- Error correction term is NOT significant
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Table 2. Causality Test Results
HK 140.56 ** 13.41 ** 117.57 ** 83.32 ** 346.88 **SG 59.13 ** 3.93 * 123.34 ** 35.60 ** 196.29 **TW 2.41 14.72 ** 51.67 ** 8.15 ** 61.66 **KW 0.93 6.64 ** 53.46 ** 32.33 ** 47.82 **
HK 8.82 ** 1.89 40.70 ** 0.90 39.89 **SG 5.66 * 2.09 19.36 ** 2.60 28.23 **TW 1.75 0.15 13.57 ** 0.80 8.21 *KW 8.78 ** 1.17 9.91 ** 0.55 9.46 **
j's = 0
j's = 0
Significance at the 10 and 5% levels indicated by 1 and 2 asterisks
j's = 0 ECT=0
j's = 0 j's = 0
j's = 0 ECT=0
j's = 0 j's = 0
Panel A: The US Causes the East Asian EconomiesPrior Crisis
Panel B: The East Asian Economies Cause the USDuring Crisis Post Crisis Entire PeriodPrior Crisis
Entire PeriodPost CrisisDuring Crisis
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Effects of the Japanese CurrencyMethodology:
- Augment with an exchange rate term
Xt = C + j=1,…,k jXt-j + j=1,…,n jYt-j + j=1,…,m jSt-j + t
Yt = C + j=1,…,k jYt-j + j=0,…,n jXt-j + j=1,…,m jSt-j + t
where
St-j = daily dollar-yen exchange rate in first log differences
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Effects of the Japanese CurrencyResults:The Japanese currency affects 4 Asian economies?- No material effects on the significance of j's and the error
correction term- Pre-crisis period: Hong Kong only- Crisis period: all- Post-crisis period: NO- Entire period: some
- yield spurious inferences about market interactions- provide erroneous information for making investment and portfolio
management decisions
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Effects of the Japanese CurrencyRobustness of the Yen effect: Transform the equity return data from local currency uni
ts to returns in the US dollar Similar result is generated
Japanese currency as a proxy of economic condition? Include the return on the Japanese Nikkei 225 index
- to test if its presence would render the yen variable insignificant
- Result: NO
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Table 3. The Japanese Currency Effect Panel A: The US Causes the East Asian Economies
HK 134.91 ** 23.16 ** 13.23 ** 129.54 ** 16.87 ** 84.20 ** 0.96 345.27 ** 1.54SG 57.35 ** 2.16 3.90 * 129.89 ** 9.05 ** 34.94 ** 0.01 195.17 ** 0.12TW 1.86 2.98 * 13.72 ** 51.71 ** 11.10 ** 6.72 ** 2.67 63.4 ** 3.48 *KW 0.81 2.20 6.38 ** 63.14 ** 31.24 ** 32.57 ** 0.23 63.91 ** 19.04 **
Panel B: The East Asian Economies Cause the US
HK 10.67 ** 3.95 * 1.80 39.42 ** 14.29 1.16 1.05 42.76 ** 9.18 **SG 6.65 ** 3.24 * 2.06 20.56 ** 16.39 * 2.78 1.05 29.22 ** 7.43 *TW 1.67 2.00 0.06 23.41 ** 25.42 ** 0.28 0.99 8.23 * 6.93 *KW 8.53 ** 1.93 1.04 10.99 ** 16.64 * 0.83 1.25 9.25 ** 6.13
Significance at the 10 and 5% levels indicated by 1 and 2 asterisks respectively.
j's = 0
j's = 0 j's = 0
j's = 0 j's = 0
j's = 0 j's = 0 ECT=0
j's = 0
j's = 0
Prior Crisis During Crisis Post Crisis Entire Period
j's = 0
j's = 0 j's = 0
j's = 0j's = 0
j's = 0 ECT=0 j's = 0
Prior Crisis During Crisis Post Crisis Entire Period
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Conclusions Confirms the dominant role of the US market in the
East Asian equity markets Information structure during the crisis period is differen
t from the non-crisis periods. The Japanese currency is found to affect these equity
markets during the crisis period, but disappears in the post-crisis sample.
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ConclusionsImplications of the changing causal relationship : Academia:
- warrant a detailed study on information flow and propagation mechanisms under different market conditions
Investment community: - different investment strategies should be pursued under diff
erent market conditions- the use of long sample data may yield obscure and even er
roneous information on market interactions.
Thank You