Does the US IT Stock Market Dominate Other IT Stock Markets? Evidence from Multivariate GARCH Model

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1 Does he US IT Sock Marke Dominae Oher IT Sock Markes? Evidence from Mulivariae GRCH Model Zhuo Qiao, Venus Khim-Sen Liew and Wing-Keung Wong RMI Working Paper No. 7/6 Submied: February, 7 bsrac Uilizing mulivariae GRCH framework, his sudy finds ha generally he US IT marke conribues a srong volailiy raher han mean spillover effec o non-us IT markes, implying ha he US IT marke plays a dominan role in affecing he volailiy of world IT markes. However, our furher analysis of he dynamic pah of correlaion coefficiens reveals ha he srong relaionship beween US and non-us IT markes had weakened afer he burs of he IT bubble. Keywords: Volailiy; Spillover Effecs; Informaion Technology; Sock markes; Mulivariae GRCH, IT Bubble. Zhuo Qiao NUS Risk Managemen Insiue and Deparmen of Economics Naional Universiy of Singapore Faculy of rs & Social Sciences S Level 6, rs Link Singapore 757 Tel: (65) Fax: (65) g3585@nus.edu.sg Wing-Keung Wong NUS Risk Managemen Insiue and Deparmen of Economics Naional Universiy of Singapore Block S6, Level 5, 6 Science Drive Singapore 7546 Tel: (65) Fax: (65) rmiwwk@nus.edu.sg Venus Khim-Sen Liew NUS Risk Managemen Insiue and Universii Malaysia Sabah, Malaysia 7 Zhou Qiao. Views expressed herein are hose of he auhor and do no necessarily reflec he views of he Berkley-NUS Risk Managemen Insiue (RMI).

2 . Inroducion The revoluion in informaion echnology (IT) in he pas decade or so, coupling wih he liberalizaion and globalizaion of goods and financial marke, has grealy enhanced he iner-linkage beween inernaional financial markes especially he world sock markes. Much evidence has been documened in he recen lieraure regarding he associaion beween correlaion and volailiy, he exisence of an increasing rend in co-movemens in inernaional sock markes and he naure of ransmission mechanism of mean and variance spillovers from one marke o ohers (Karolyi, 995; Hamori and Imamura, ; Caporale e al., ; Liao and Williams, 4; Morana and Belrai, 6). Noneheless, sudies ha focus on inerdependence among indusry-based sock markes are relaively rare. mong he few, Jorge and Iryna () scruinized he Telecommunicaions, Media and Technology (TMT) and non-tmt secors, whereas Jeon and Jang (4) focused he echnology-based socks only. Following he spiri of hese wo recen sudies, bu focusing on he IT secor and using more recen economeric approach, he curren research aemps o sudy he spillover effecs among he IT-based sock markes. Specifically, he naure of spillover effecs, if any, beween US and he non-us IT markes is of special ineres. This sudy is moivaed by he observaion ha he business cycle of he recen US and he world economy is closely associaed o he growh of IT secors (Oliner and Sichel, ; Maich, 3). Imporanly, Jorge and Iryna () found, based on T-GRCH modelling, ha he US marke plays an imporan role in deermining price dynamics in sia-pacific sock markes for boh secors, whereas Jeon and Jang (4) discovered, from vecor auoregression analysis, ha only a unidirecional causaion from he US high echnology o he Souh Korean high echnology markes. s he US IT indusry is believed o hold a leading posiion in he world, his sudy only examines he linkages beween he US IT marke and he IT markes in he non-us counries, no among non-us counries. 3

3 should spillovers exis, invesors and porfolio managers have o closely monior he movemens in boh markes and carefully devise heir globally invesmen sraegy accordingly. Firs, spillovers imply inernaional diversificaion sraegy should be adoped wih acive porfolio managemen. Second, discovering he causaliy direcion of spillovers may provide useful insighs in beer undersanding he long-run direcion of a sock marke based on ohers. Third, he ransmission mechanism of mean or variance spillovers may produce beer economeric models in describing he emporal behavior of inernaional sock markes. This sudy is confined he examinaion of he spillover effecs beween he informaion echnology (IT) sock marke in he Unied Saes and hose in Japan, France, Canada, Finland, Sweden and Hong Kong. The mulivariae represenaion of GRCH model iniially formulaed by Baba e al. (BEKK, 99), or he so-called BEKK GRCH model, which has he advanage of allowing one o invesigae he lead-lag relaionships or informaional spillover effecs of wo or more variables, boh he firs (causaliy in mean) and second order (causaliy in variance) specificaions, is uilized in his sudy. This model has gained is populariy in financial marke sudies o es for he volailiy ransmission or spillover effecs afer he seminal work of Engle and Kroner (995) 3. Considering he usefulness of his model in he idenificaion of informaional spillover effecs in financial markes, his sudy, herefore, adops i o analyze inernaional linkages beween he informaion echnology socks.. Daa and he Model 3 Karolyi (995), for insance, uilized his framework o model inernaional ransmissions of sock reurns and volailiy in he conex of US and Canada, whereas Caporale e al. () applied i o he Eas sian markes o examine he causaliy relaionship beween sock prices and exchange raes volailiy. More recenly, Liao and Williams (4) employed his framework o model sock marke inerdependence in groups of European Communiy. 4

4 The weekly IT indices of he Unied Saes (US), Japan (JP), France (FR), Canada (C), Finland (FIN), Sweden (SWE) and Hong Kong (HK) aken from DaaSream Inernaional covering he period from January 995 o December 5 wih he oal number of observaions o be 574 are employed in our sudy. The weekly Wednesday indices are uilized o alleviae he effecs of noise characerizing daily daa and o avoid he day-of-he-week effec (Lo and MacKinlay, 988). In addiion, o avoid exchange rae bias, all indices are expressed in US dollars. The weekly coninuously compounded rae of reurn, r, on dae is defined as: r = (ln p ln p ) () where p is he corresponding price index on dae for each of he IT sock price indices. The descripive saisics of he resuling weekly reurns reveal ha, he reurns are ypically lef-skewed, playkuric and non-normal 4. More imporanly, he Ljung-Box saisic suggess he exisence of srong serial correlaion in he squared levels of all he sock reurns, hereby revealing he presence of ime-varying volailiy such as GRCH effecs in hese series. In he vein of Karolyi (995) and Liao and Williams (4), he following bivariae BEKK GRCH(,) framework is hen adoped o model he dynamic linkages beween he wo IT markes in erms of boh mean and volailiy spillover effecs (Baba e al., 99; Engle and Kroner, 995) 5 : r r = c = c φ r φ r φ r φ r ε ε () 4 The resuls are available on reques. 5 This specificaion is usually sufficien o model volailiy in financial ime series (Baba e al., 99). 5

5 r r where and denoe he sock index reurns on US and he individual non-u.s IT sock ' markes respecively. The vecor of error erms, ε = ε, ε condiional on he pas ( ) informaion se Ω is specified as: ε Ω ~ N(, ) (3) where σ = σ σ σ = ' ( ε ε ) B B ' ' ' is he symmeric and posiive semi-definie variance-covariance marix of ε, is a lower riangular marix, and and of B are unresriced square marices. This framework enables us o examine he dynamics fully. Usefully, i allows for he ineracion beween he condiional variances and covariances, hereby allowing us o observe he conemporaneous informaion flows across marke. The expansion of BEKK (, ) ino individual dynamic equaions generaes he following variance and covariance equaions: ( ) ( B ) B B ( B ) σ = ε ε σ σ σ, ( ) ( ) ( B ) B B ( B ) σ = ε ε σ σ σ, σ = ε ( ) ε ε ε BBσ ( ) BB BB σ BBσ. (4) This BEKK specificaion is a more general and flexible mulivariae GRCH model as here is no resricion imposed on he coefficiens bu hey conain all he RCH and GRCH iems in he equaions; see Baba e al. (99) for more deails. Remarkably, in his framework, he dynamics of he condiional variance and covariance are modeled direcly and he 6

6 volailiy spillover effecs across reurn series indicaed by he off-diagonal enries of coefficien marices and B can also be esimaed. Paricularly, he ( ) measures he mean spillover effecs from he non-us (US) o he US (non-us); whereas and ( and ) measure he volailiy spillover effecs from he non-us (US) o he US B B (non-us) sock marke. φ φ 3. Empirical Resuls The esimaed VR()-BEKK GRCH(,) models is presened in Table. mong he esimaes of mean equaions, he highly-significan posiive esimaes of φ for US-HK and US-JP sugges ha here are mean spillover effecs from he US IT sock marke o boh Japan and Hong Kong IT sock markes. On he oher hand, posiive mean spillover effecs from France, Canada and Sweden IT sock markes o he US IT sock marke are revealed by he significanly posiive esimaes of φ. s for US and Finland, no mean spillover is deeced in eiher direcion. ll-in-all, i can be concluded ha US IT marke does no play a dominan role in mean spillover effec as i conribues a mean spillover effec o only a few oher IT markes bu, on he oher hand, some oher IT markes also generae significan mean spillover effecs o he US IT marke. Inser Table here s for volailiy spillover effec, i is found ha he volailiy in US IT marke has been ransmied o all oher IT markes, based on he significanly posiive esimaes of B (excep Canada). Conversely, Hong Kong is he only counry wih significan posiive esimaes of and B, implying ha excluding Hong Kong, oher IT markes have no significan 7

7 influence on he volailiy of US IT marke. To solici furher insighs on he dynamic evoluion pah of correlaion beween he IT markes, he ime-varying condiional correlaion coefficiens esimaed from he VR ()-BEKK (, ) model for each pair of markes are depiced in Figure. This figure provides some ineresing sylized facs: For he period 999-, i.e. he period of he formaion, spread and collapse of he IT bubble, he correlaion beween US and non-us IT markes is high and exhibis an upward rend, indicaing he marke relaions are very close during he IT bubble which becomes a global even o affec each sock marke significanly. However, afer he burs of he IT bubble, he correlaion pah exhibis seep downward rend, suggesing ha he relaion beween US and non-us IT marke has weakened ever since. Inser Figure here 4. Conclusions Based on mulivariae GRCH framework of Baba e al. (99), his sudy find ha generally he US IT marke conribues a srong volailiy raher han mean spillover effec o non-us IT markes, implying ha he US IT marke plays a dominan role in affecing he volailiy of world IT markes. However, our furher analysis of he dynamic pah of correlaion coefficiens reveals ha he srong relaionship beween US and non-us IT markes had weakened afer he burs of he IT bubble. From he policy perspecive, i can be said ha while mean sock reurn may, o some exen, be insighful, invesors and porfolio managers can beer undersand he behaviour of hose IT socks ouside he US by closely monioring he volailiy of he US IT sock reurn. Besides, invesing in US and non-us IT socks simulaneously should provide no diversificaion benefi. 8

8 References Baba, Y., Engle, R.F., Krafe, D., Kroner, K.F., 99. Mulivariae simulaneous generalized RCH. Unpublished Manuscrip, Deparmen of Economics, Universiy of California, San Diego. Caporale, M. G., Pias, N. and Spagnolo, N.. Tesing for causaliy in variance: an applicaion o he Eas sian markes. Inernaional Journal of Finance and Economics 7, Engle, R.F., Kroner, K.F., 995. Mulivariae simulaneous generalized RCH. Economeric Theory, 5. Hamori, S., Imamura,Y.,. Inernaional ransmission of sock prices among G7 counries: L-VR approach. pplied Economics Leers 7, Jeon, B.N., Jang B.S., 4. The linkage beween he US and Korean sock markes: he case of NSDQ, KOSDQ, and he semiconducor socks. Research in Inernaional Business and Finance 8, Jorge, C.H., Iryna, I.,. sian flu or Wall Sree virus? Price and volailiy spillovers of he ech and non-ech secors in he Unied Saes and sia. IMF Working Paper WP//54. Karolyi,.G., 995. Mulivariae GRCH model of inernaional ransmissions of sock reurns and volailiy: he case of Unies Saes and Canada. Journal of Business and Economics Saisics 3, 5. Liao,., Williams, J., 4. Volailiy ransmission and changes in sock marke inerdependence in he European Communiy. European Review of Economic and Finance 3, 3 3. Lo,.W., MacKinlay,.C., 988. Sock marke prices do no follow random walks: evidence from a simple specificaion es. Review of Financial Sudies,

9 Maich, S., 3. nalyss ry o jusify laes inerne rise: a boom or bubble? Naional Pos, 9 Sepember,. Morana, C., Belrai,., 6. Comovemens in inernaional sock markes. Inernaional Financial Markes, Insiuions and Money, in press. Oliner, S., Sichel, D.,. The resurgence of growh in he lae 99s: is informaion echnology he sory? Journal of Economic Perspecives 4, 3.

10 Table Esimaes for VR ()-BEKK GRCH(, ) Models Esimaes Models US-JP US-FR US-C US-FIN US-SWE US-HK c.35(.5)**.35(.63)*.9(.6).3(.9)*.97(.67)*.379(.8)** c.84(.66).3(.).5(.37).594(.86)**.4(.38).69(.58) φ -.56(.5) -.8(.57)* -.45(.55)*** -.8(.6) -.3(.54)** -.55(.53) φ -.9(.36).95(.4)**.7(.3)**.53(.37).6(.8)**.3(.3) φ.7(.4)***.34(.6) -.87(.8).3(.76) -.9(.95).58(.63)*** φ -.56(.4).(.58).6(.63)* -.69(.57) -.(.68).8(.5).38(.86).38(.89).99(.75).6(.58).385(.69).38(.6)* -.43(.59) -.693(6.33) -.87(.687).447(.4) -.758(.668).435(.448)***.33(.866).653(.).9(54.85).63(8.).9(5.54).(.4).87(.45)***.7(.55)***.49(.46)***.68(.49)***.37(.47)***.7(.49)**.3(.3).44(.4).6(.37) -.8(.35).8(.7).73(.3)*** -.3(.45) -.8(.63)* -.6(.7).7(.78) -.43(.78) -.4(.73).96(.3)***.376(.44)***.3(.57) ***.3(.43)***.6(.3)***.4(.38)*** B.96(.7)***.989(.6)***.97(.6)***.993(.6)***.969(.8)***.995(.9)*** B -.6(.) -.3(.6) -.3(.3) -.7(.) -.8(.8) -.37(.8)*** B.33(.5)**.65(.)***.4(.7).7(.37)**.56(.5)**.8(.6)* B.96(.)***.9(.)***.933(.)***.98(.6)***.96(.8)***.895(.7)*** ij ij Noe: The esimaes are based on equaions () o (4) in he ex. The firs-order and B erms are he elemens of he RCH and GRCH coefficien marices and B in Equaions (3) and (4). Numbers in parenheses are sandard errors. ***, ** and * indicae significance a he, 5 and % level, respecively.

11 US-JP US-FR US-C US-FIN US-SWE US-HK Figure Conemporaneous correlaions among he IT markes