Are Stock Markets Integrated? Evidence from a Partially Segmented ICAPM with Asymmetric Effects. AROURI Mohamed El Hedi *

Transcription

1 Are Sock Markes Inegraed? Evdence from a Parally Segmened ICAPM wh Asymmerc Effecs. AROURI Mohamed El Hed * LEO & EconomX, Unversy of Pars X, 200, avenue de la Républque Nanerre 92001, France. mohamed-el-hed.arour@u-pars10.fr Absrac In hs paper, we es a parally segmened ICAPM for wo developed markes, wo emergng markes and World marke, usng an asymmerc exenson of he mulvarae GARCH process of De Sans and Gerard (1997,1998). We fnd ha hs asymmerc process provdes a sgnfcanly beer f of he daa han a sandard symmerc process. The evdence obaned from he whole perod and sub-perods analyss suppors he fnancal negraon hypohess and suggess ha domesc rsk s no a prced facor. Keywords: Inernaonal Asse Prcng, Fnancal Inegraon, Emergng Markes, Mulvarae GARCH. (JEL Classfcaon : F36; C32; G15) * We would lke o hnk Georges Pra and he referees for helpful commens and suggesons whch have grealy mproved hs sudy.

2 1 INTRODUCTION Deermnng he exen o whch a naonal marke s negraed n he world sock marke s an emprcal queson whch has decsve mpac on a number of ssues affecng problems ha are addressed by fnancal marke heory. If capal markes are fully negraed, nvesors face common and counry-specfc rsks, bu prce only common rsk facors because counry-specfc rsk s fully dversfed. In hs case, he same asse prcng relaonshps apply n all counres and expeced reurns should solely be deermned by global rsk facors. In conras, when capal markes are segmened he asse prcng relaonshp vares across counres and expeced reurns would be deermned by domesc rsk facors. When capal markes are parally segmened, nvesors face boh common and counry-specfc rsks and prce hem boh. In hs case, expeced reurns should be deermned by a combnaon of local and global rsk sources. Thus, expeced gans from world porfolo dversfcaon and crera for capal budgeng decsons wll be que dfferen under local, global and mxed prcng. Emprcal papers nvesgang sock marke negraon have been manly lmed o developed markes. These papers nclude, among ohers, Dumas and Solnk (1995), De Sans and Gerard (1997,1998), Hardouvels e al. (2002), Aggarwal e al. (2003) and Gerard e al. (2003). The fndngs of hese sudes suppor he fnancal negraon hypohess of developed equy markes. Recenly, some papers have ened o focus on emergng markes, n parcular Asan equy markes, parly as a resul of her hgh rees of economc growh and he 1997 Asan crss. The resuls of hese sudes are heerogeneous. Mash and Mash (1997) show usng conegraon mehods ha he Asan Newly Indusralzng Counres of Honk Kong, Sngapore, Tawan and Souh Korea share long run relaonshp wh developed markes (U.S., Japan, U.K. and Germany). Mash and Mash (1999) apply recen economerc mehods ncludng vecor errorcorrecon and level VAR models and fnd smlar resuls. More recenly, Mash and Mash (2001) sudy he dynamc causal lnkages amongs nernaonal sock markes. They fnd sgnfcan nerdependences beween he esablshed OECD and he emergng Asan Markes. In parcular, her resuls show he leadershp of he US and he UK markes boh n he shor and long erm, despe he global fnancal crash of Ocober Lm e al. (2003) examne he lnkages beween sock markes n he Asan regon over he perod usng non-paramerc conegraon echnques and fnd ha here s a common force whch brngs hese markes ogeher n he long run. In conras, Roca and Selvanahan (2001) show usng dfferen recen economerc echnques ha here s no shor-erm and long-erm lnkages among he sock markes of Ausrala, Hong Kong, Sngapore and Tawan. Phylaks and Ravazzolo (2000) sudy he poenal lnkages beween sock prces and exchange rae dynamcs for a group of Pacfc-Basn capal markes and show lack of comovmen durng he eghes for he free sock markes of Sngapore and Hong Kong. On he oher hand, recen works sress he fac ha he level o whch markes are negraed or segmened s no fxed, bu changes gradually over me. Bekaer and Harvey (1995) esmae he degree of negraon for developed and emergng markes and show ha ndeed sock markes become eher more or less negraed over me. Lu and pan (1997) fnd ha he US marke s more nfluenal han he Japanese marke n ransmng reurns and volales o he Asan markes and ha he observed spllover effecs are unsable over me and ncrease subsanally afer he Ocober 1987 sock mrke crash. Blson e al. (2000) show ha he regonal negraon among sock markes n Souk Korea, Tawan, Thaland, he Phlppnes and Malaysa s faser han her negraon whn he nernaonal marke. Hooever, Barar (2003) compare he saus of regonal vs-a-vs global negraon of sx Lan Amercan equy markes over he perod usng me-varyng negraon score. The emprcal evdence shows ha negraon s me varyng and suggess ncreased global relave o regonal sock marke negraon n recen years. Raanapakon and Sharma (2002) sudy he shor and long-erm relaonshps n fve regonal sock ndces for he pre-asan crss and for he crss perod. They fnd ha he degree of lnkage ncresed durng and afer he crss perod. However more recenly, Phylaks and Ravazzolo (2004) apply mulvarae conegraon mehods o nvesgae sock marke neracons amongs a group of Pacfc-Basn counres and he ndusralzed counres of Japan and US over he perod They show ha alhough he lnkages have ncreased n recen years, here s room for long-erm gans by nvesng n Pacfc-Asan markes. In parcular, her resuls show ha he Asan crss dd no have a subsanal effec on he degree of lnkages of hese markes. In he curren paper, we esmae a parally segmened nernaonal capal asse prcng model (ICAPM) where boh local and global sources of rsk are prced. The man purpose of he paper s o examne he poenal negraon of wo Pacfc-Basn counres (Hong Kong and Sngapore), U.K. and U.S. wh he world marke. The wo emergng Asan markes ncluded n he sudy have enjoyed remarkably rapd economc growh n he pas decades and are ganng ncreased nfluence n he world capal markes. Therefore, he negraon of hese markes wh developed markes deserves closer aenon. Ths ssue s checked for he perod , and

3 based on he Ocober 1987 sock marke crash, usng he pre-ocober 1987 perod, and hen he pos-ocober 1987 perod. Ths sudy s prmarly movaed by several reasons. Frsly, mos sudes ha examne he nerdependence beween nernaonal sock markes use conegraon mehods and hen es ndrecly he sock marke negraon hypohess. Moreover, a weakness of conegraon mehods s ha a focus on comparave sacs does no ake no accoun he me varaon n equy rsk prema (see for nsance, Harvey (1991) and Bekaer and Harvey (1995)), whch may yeld confusng and paral resuls. To accommodae hs feaure of he daa, we esmae a dynamc verson of he model, n whch boh he prces and quanes of rsk vary over me. Secondly, snce a number of sudes have documened ha nernaonal equy marke negraon changes over me, he ncluson of a longer sample perod perms us o nvesgae he mpac of changes n world sock marks on he degree of negraon. Thrdly, emprcal papers nvesgang drecly sock marke negraon have been manly lmed o developed markes and only some papers have ened o focus on emergng markes. As shown obove, he resuls of hese sudes are heerogeneous. In hs paper, he dynamc ICAPM s esmaed usng a mulvarae GARCH process smulaneously for 5 markes: he world marke, 2 developed markes and 2 emergng markes. Fnally, f, as s argued n unvarae and bvarae cases by Glosen e al. (1993) and Kroner and Ng (1998), he condonal varances and covarances are hgher durng sock marke downurns, he economerc specfcaon should allow for asymmerc effecs n varances and covarances. In he curren paper, we develop an asymmerc exenson of he mulvarae GARCH-n-Mean process of De Sans and Gerard (1997,1998). Ths approach, wh sgn and sze asymmerc effecs, allows o he prces of domesc and world marke rsks, beas and correlaons o vary asymmercally hrough me. The res of he paper s organsed as follows. Secon 2 presens he model and nroduces he economerc mehodology. Secon 3 descrbes he daa. Secon 4 repors he emprcal resuls. Concludng remarks are n secon 5. 2 THE MODEL AND EMPIRICAL METHODOLOGY The Capal Asse Prcng Model (CAPM) predcs ha he expeced excess reurn on an asse s proporonal o s nondversfable rsk measured by s covarance wh he marke porfolo. Under he hypohesses of sock marke negraon and purchasng power pary, an nernaonal condonal verson of he CAPM can be wren as: where E R / R CovR, R / f 1 W 1, 1 (1) R s he reurn on asse beween me (-1) and, R f s he reurn on a rsk-free asse and reurn on he marke porfolo. 1 s he prce of world marke rsk and s equal o he world aggregae rsk averson coeffcen, see Meron (1980) and Adler and Dumas (1983). All expecaons are aken wh respec o he se of nformaon varables 1. However, many recen sudes show ha expeced reurns n mos markes are nfluenced by boh global and local rsk facors,.e. mos markes are neher fully negraed nor compleely segmened, see among ohers, Bekaer and Harvey (1995), Karoly and Sulz (2002), Carrer e al. (2002), Gerard e al. (2003) and Barr and Presley (2004). In hs parally segmened framework, expeced reurns should be deermned by wo rsk facors: global marke rsk and resdual domesc rsk. E R / R CovR, R / Var / 1 f 1 W 1 d, 1 1, R W s he (2) where d, 1 s he prce of domesc rsk and s he marke model resdual. Thus, ( Var( / 1) ) capures he domesc marke nondversfable rsk uncorrelaed o world rsk; 2 / Var R / CovR, R / Var R Var. (3) 1 1 W 1 W/ Nex, consder he economerc mehodoloy. Equaon (2) has o hold for every asse ncludng he marke porfolo. A benchmark sysem of equaons can be used o es he parally negraed condonal ICAPM. For an economy wh N rsky asses, he followng sysem of prcng resrcons has o be sasfed a each pon n me: 1

4 R R h q (4) f 1 N d, 1 * / 1 0, where q DH hn * hn / hnn, and R denoes he N 1 vecor ha ncludes N 1 rsky asses and he marke porfolo, an N-dmensonal vecor of ones. s he N N condonal covarance marx of asse reurns, h N s he N h column of composed of he condonal covarance of each asse wh he marke porfolo and hnn he condonal varance of he world marke porfolo. d, 1 s he N 1 vecor of mevaryng prces of domesc rsk, q s he N 1 vecor on nondversfable local rsk, D H he dagonal componens n and * denoes he Hadamard marx produc. The dynamcs of condonal momens are lef unspecfed by he model. However, has been shown ha secures exhb volaly cluserng and lepokuross. Such characerscs are aken no accoun by ARCH specfcaon. Moreover, f, as s argued n unvarae and bvarae cases by Glosen e al. (1993) and Kroner and Ng (1998), he condonal varances and covarances are hgher durng sock marke downurns, he economerc specfcaon should allow for asymmerc effecs n varances and covarances. To accommodae hs feaure of he daa, we develop an asymmerc exenson of he mulvarae GARCH process proposed by De Sans and Gerard (1997). Formally, H can be wren as follows: CC aa bb ss zz (5) * 1 1 * 1 * 1 1 * 1 1 where I where I 1 f 0 oherwse I 0, I where I 1 f h oherwse 0, C s a N N lower rangular marx, h s he condonal varance of asse and a, b, s and z are N 1 vecors of unknown parameers. Ths parameersaon mples ha he varances n H depend asymmercally only on pas squared resduals and an auoregressve componen, whle he covarances depend asymmercally upon pas cross-producs of resduals and an auoregressve componen. In parcular, guaranees ha he condonal varance marx s defne and posve. We fnd he symmerc GARCH process of De Sans and Gerard (1997) when s z 0. Nex, urn o he prce of rsk. The evdence n Harvey (1991) and De Sans and Gerard (1997) suggess ha he prce of rsk s me varyng. Furhermore, Meron (1980) and Adler and Dumas (1983) show he prce of world marke rsk o be equal o he world aggregae rsk averson coeffcen. Snce mos nvesors are rsk averse, he prce of rsk mus be posve. In hs paper, we follow De Sans and Gerard (1997), De Sans e al. (2003) and Gerard e al. (2003) and model he dynamcs of he rsk prces as a posve funcon of nformaon varables: 1 exp W Z 1 and d, 1 exp Z 1, where Z and Z are respecvely a se of global and local nformaon varables ncluded n 1 and s a se of weghs ha he nvesor uses o evaluae he condonally expeced reurns. Fnally, noe ha he varables we use o condon he prces of domesc rsks are correlaed wh he degree of openness and developmen of he local sock markes, hen he model allows mplcly he degree of negraon o change over me. Equaons (4) and (5) consue our benchmark model. Under he assumpon of condonal normaly, he loglkelhood funcon can be wren as follows: T T TN lnl( ) ln(2 ) ln ( ) ( ) ( ) ( ) (6) where s he vecor of unknown parameers. To avod ncorrec nference due o he msspecfcaon of he condonal densy of asse reurns he quas-maxmum lkelhood (QML) approach of Bollerslev and Wooldrdge (1992) s used. Smplex algorhm s used o nalze he process, hen he esmaon s performed usng BHHH algorhm. 1

5 3 DATA AND PRELIMINARY ANALYSIS Ths secon serves wo purposes. Frs, we nroduce he daa we use n our emprcal nvesgaon. Second, we show ha he daa conans feaures ha can be capured wh a GARCH model. The daase ncludes wo dsnc groups of daa: he reurns seres and he global and domesc nformaon varables used o condon he esmaon. We use monhly reurns on sock ndexes for four counres plus a value weghed world marke ndex over he perod February 1970 December Gven he am of he paper, we selec wo large markes (he Uned Saes and he Uned Kngdom) and wo small markes (Hong Kong and Sngapore). All he ndces are obaned from Morgan Sanley Capal Inernaonal (MSCI) and nclude boh capal gans and dvdend yelds. Reurns are compued n excess of he 30-day Eurodollar depos rae obaned from DaaSream and expressed n Amercan dollar. Descrpve sascs for he excess reurns are repored n Table 1. Table 1 reveals a number of neresng facs. The Bera-Jarque es sasc srongly rejecs he hypohess of normally dsrbued reurns, whch suppors our decson o use QML o esmae and es he model. The values of he uncondonal correlaons are relavely low. The lack of auocorrelaon n he reurn seres reveals ha we do no need o nclude an AR correcon n he mean equaons. For he squared reurns, auocorrelaon s deeced a shor lags, whch suggess ha GARCH parameersaon for he second momens mgh be approprae. Panel E of able I conans he cross-correlaons of squared reurns beween he world and he oher counres a dfferen leads and lags. Wh few excepons, only he conemporaneous correlaons are sascally sgnfcan. Ths evdence suggess ha, a leas wh our monhly daa, he croos-marke dependence n volaly s no srong and ha he dagonal GARCH parameersaon for he second momens s no oo resrcve. Fnally, noe ha emprcal research has found suppor for a me-varyng prce of rsk, see for examples, Harvey (1991), Bekaer and Harvey (1995) and Dumas and Solnk (1995). The prce of rsk s ofen modelled as a funcon of a ceran number of nsrumens, whch are desgned o capure expecaon abou busness cycle flucuaons. The logc whch jusfes he use of hese nsrumens s ha nvesors become more rsk averse durng economc roughs whle he marke prce of rsk decrease durng expansonary phases of he busness cycle. However, he CAPM s a paral equlbrum model and does no specfy sae varables ha can explan he observed dynamcs of he prces of rsk. Prevous sudes used as condonng nformaon se varables ha are conneced wh he evoluon of fnancal markes. These condonng nsrumens are nended o convey he nformaon avalable o nvesors. In order o preserve he comparably beween hs sudy and ohers sudes, he choce of global and local nformaon varables s manly drawn from prevous emprcal leraure n nernaonal asse prcng, see Harvey (1991), Ferson and Harvey (1993), Bekaer and Harvey (1995) and De Sans and Gerard (1997,1998). The se of global nformaon ncludes a consan, he MSCI world dvdend prce rao n excess of he 30-day Eurodollar depos rae (WDY), he change n he US erm premum spread measured by he yeld on he enyear US Treasury noe n excess of he one-monh T-Bll rae (DUSTP), he US defaul premum measured by he dfference beween Moody s Baa-raed and Aaa-raed corporae bonds (USDP) and he change on he one monh Euro$ depos rae (DWIR). The se of local nformaon ncludes a consan, he local dvdend prce rao n excess of he local shor-erm neres rae (LDY), he change n he local shor-erm neres rae (DLIR) and and he change n ndusral producon (DIP). Informaon varables are from MSCI, he Inernaonal Fnancal Sascs (IFS) and DaaSream and are used wh one-monh lag relave o he excess reurns. Summary sascs for he condonng nformaon varables, no repored here n order o preserve space bu avalable on reques, show ha he correlaons among he nformaon varables are low. Hence, our proxy of he nformaon se conans nonredundan varables. 4 EMPIRICAL RESULTS We frs esmae, over he full perod, he model wh he symmerc GARCH process of De Sans and Gerard (1997) and hen wh he asymmerc GARCH process dscussed earler n he paper. Panel A of Table 2 repors he resuls of a lkelhood rao es of he symmerc versus he asymmerc process. The es rejecs he symmerc specfcaon n favor of he asymmerc one. Smlar resuls are gven by he Akake and Schwarz crerons presened n Panel B. Resdual sascs repored n Panel C show ha average mean resdual s closer o zero usng he asymmerc specfcaon. To sum up, our fndngs show ha he parally negraed ICAPM wh asymmerc GARCH process fs he daa beer han he symmerc process of De Sans and Gerard (1997). Table 3 conans parameer esmaes and a number of dagnosc ess for he parally segmened condonal ICAPM wh asymmerc GARCH process esmaed over he full perod

6 The ARCH coeffcens and GARCH coeffcens repored n panel B are sgnfcan for all asses. Ths s n lne wh prevous resuls n he leraure. The coeffcens a are relavely small n sze, whch ndcaes ha condonal volaly does no change very rapdly. However, he coeffcens b are large, ndcang gradual flucuaons over me. One of he advanages of our approach s o auhorze for asymmerc varance and covarance effecs. The sgnfcan coeffcens n he vecor s mply ha he condonal varance s hgher afer negave shocks for he Uned Saes, Sngapore and Hong Kong. The sgnfcan coeffcens n s are all posve, whch mples ha condonal covarances beween hese counres ncrease afer common negave shocks. In he same way, he sgnfcan coeffcens n vecor z ndcae ha he condonal varance s hgher afer shocks large n absolue value for he US, UK and world marke. The sgnfcan coeffcens n z have he same sgn (negave). Ths resul shows ha condonal covarances beween hese sock markes ncrease afer large common negave or posve shocks. Panel A of Table 3 shows he mean equaon parameer esmaes and Panel C repors some specfcaon ess. For he world prce of rsk, he consan and he coeffcens of he world dvdend prce rao, he erm premum and he defaul premum are sgnfcan. The average prce of marke rsk s equal o 3.54 and s hghly sgnfcan, whch s conssen wh he fndngs by earler sudes. On he oher hand, he condonal verson of he model mples ha nvesors updae her sraegy usng he new avalable nformaon. Thus, here s no reason o beleve ha he equlbrum prce of rsk wll say consan. The robus Wald es for he sgnfcance of he me-varyng parameers n he prce of world marke rsk rejecs he null hypohess a any sandard level. Fgure 1 plos he esmaed prce of world marke rsk. Rsk averse nvesors should demand hgher expeced reurns a mes of hgh expeced rsk n he economy. Thus, a mes of uncerany he prce of rsk should be hgher han a mes of calm. Ths seems o be confrmed n he fgure 1. In fac, he spkes n he condonal prce of rsk n fgure 1 are assocaed wh he ol crss ( ), he moneary expermen ( ), he Ocober 1987 crash, he Gulf war (1990), he Asan fnancal crss ( ) and he errors aacks on US (2001). As n earler sudes, he pon esmaes are very nosy. Snce we are especally neresed n he rend n he seres, he Hodrck and Presco (1986) fler (HP) s used o separae he shor-erm componens from he longerm componen. A smple vsual nspecon of he char shows ha he prce of marke rsk reaches s hghes values n he Sevenes and he early Eghes. Beween 1994 and 2000, becomes much lower. Fnally, he prce of world marke rsk ncreases sgnfcanly n he las years of our sample. Concernng he prces of domesc resdual rsk, he resuls show ha none of he esmaed coeffcens of local nformaon varables are sgnfcan. The sample means of he prces of domesc rsk are 0.68 for he US, 0.95 for Sngapore, 1.12 for he UK and 1.63 for Hong Kong. As expeced, he prces of domesc rsk are all nsgnfcan. The robus Wald ess confrm hese resuls and sugges ha domesc rsk s no a prced facor,.e. over he sample perod he marke consdered were fully negraed. In fac, he null hypohess ha he domesc rsk prce coeffcens are jonly equal o zero canno be rejeced a any sandard level. Ths resul s confrmed by he sngle counry ess. To sum up, no evdence of fnancal segmenaon s deeced over he full perod Nex, we consder a number of robusness ess. To address hs ssue, we esmae an augmened verson of he model ha ncludes, n addon o marke and domesc rsk, a counry specfc consan and he local nsrumenal varables Z : R CovR R Var ' /, / / Z E R (7) 1 f 1 W 1 d, 1 1 1, The ncluson of he counry-specfc consans can be nerpreed as a measure of mld segmenaon or as an average measure of oher facors ha canno be capured by he model lke dfferenal ax reamen. The ncluson of local nsrumenal varables can be nerpreed as a way o es wheher any predcably s lef n he local nformaon varables afer hey have been used o model he dynamcs of he domesc rsk prces. The es resuls are repored n Table 4. The Wald es ndcaes ha he counry nerceps are no jonly dfferen from zero. On he oher hand, he null hypohess ha he local nformaon varable coeffcens are jonly equal o zero canno be rejeced a any sandard level. Taken ogeher, our resuls suppor he fnancal negraon hypohess and sugges ha domesc rsk s no a prced facor. These resuls are conssen wh he fndngs of De Sans and Gerard (1997,1998) and Gerard e al. (2003). However, such concluson seems o be a srong one. I smply mples ha he analysed markes are fully negraed along he enre me perod covered n he hs sudy, whle many recen sudes sress he fac ha he level o whch sock markes are negraed or segmened s no fxed, bu changes gradually over me, see, for examples, Bekaer and Harvey (1995), Lu and pan (1997), Blson e al. (2000), Raanapakon and Sharma (2002), Aggarwal e al. (2003), Huner (2004) and Phylaks and Ravazzolo (2004). Furhermore, Fgure

7 2, whch plos for each marke he condonal correlaon wh he world marke, shows ha correlaons have sgnfcanly ncreased durng he recen years a leas for he UK and Hong Kong. The ncreased me-varyng correlaons explan why he whole sample uncondonal correlaons repored n Table 1 are que low and sugges hgher degrees of sock marke negraon. Therefore, s neresng o nvesgae wheher he nferences have changed over me and wheher he resuls are sensve o he choce of he sample perod. In he res of he paper, we explore changes n paerns of dynamc negraon among naonal sock marke ndces followng he Ocober 1987 crash. In fac, as shown n Table 1, he wors monh for all sock markes, ncludng he world marke, s relaed o he marke crash of Ocober Ths s clearly a sympom of nernaonal conagon. Many emprcal works argued ha he nerdependences beween nernaonal sock markes have ncreased afer he Ocober 1987 crash, see, among ohers, Jeon and Von Fursenberg (1990), Lau and McLnsh (1993), Arshanapall and Doukas (1993) and Lu and Pan (1997). The ncreased nerdependences may reflec hgher levels of negraon and herefore, s reasonable o queson wheher he degrees of sock marke negraon are unduly nfluenced by he Ocober 1987 crash. So, dvdng he full sample perod no wo sub-perods, up o Ocober 1987 and snce Ocober 1987, seems approprae for examnng he evoluon of sock marke negraon. On he oher hand, n he laer half of he 1980s and early years of he 1990s, mos of governmens gradually lberalzed her sock markes. In heory, he lberalzaon should brng abou more negraed local markes wh global sock markes. However, marke lberalzaon s neher a necessary nor a suffcen condon for nernaonal sock marke negraon. In fac, oher facors may exer an effec, such as nformaon avably, accounng sandards, lqudy, polcal and currency rsks. On he oher hand, here can also be a suon n whch foregn nvesors use alernave nsrumens, for nsance counry funds, o ener capal markes wh foregn resrcons, see Bekaer (1995), Bekaer and Harvey (2000) and Phylaks and Ravazzolo (2004). Therefore, I s also naural o queson wheher he levels of negraon have changed as naonal sock markes have become more lberalzed. The second sub-perod defned above can also be consdered as he pos lberalzaon perod. One may expec hgher negraon beween naonal sock markes n hs sub-perod. We re-esmae he model over he sub-perods Febraury 1970-Sepenber 1987 and Ocober 1987-December Snce we are especally neresed n he sgnfcance of he prces of local marke rsk, robus Wald ess are used o evaluae jon hypoheses on hese prces of rsk. The resuls of ha exercse are summarzed n Table 5. In order o preserve space, mean and varance equaon parameer esmaes are no repored here bu are avalable on reques. For he sub-perod , excep for he consan erm for Hong Kong, he resuls show ha none of he esmaed coeffcens of local prces of rsk are sgnfcan. The sample means of he prces of domesc rsk are 0.92, 1.35 and 1.56 respecvely for he US, UK and Sngapore and are all nsgnfcan. However, for Hong Kong he prce of local rsk s equal o 2.08 and s sgnfcan a 5%. These resuls are confrmed by he robus Wald ess ha sugges ha domesc rsk s no a prced facor for he US, UK and Sngapore sock markes and ha he null hypohess ha he domesc rsk prce for Hong Kong s equal o zero s rejeced a 5%. However, he Wald es shows ha he domesc rsk prce for Hong Kong s no me varyng. Fnally, he Wald es can no rejec he null hypohess ha he four domesc rsk prcees are jonly equal o zero. To sum up, over he sub-perod we fnd ha he sock markes of he US, UK and Sngapore are fully negraed n he world capal marke, whle we fnd weak suppor for he hypohess ha he Hong Kong capal marke s parally negraed n he world marke. Nex, we consder he second sub-perod For hs sub-perod, our fndngs are smlar o hose obaned for he whole perod. In parcular, none of he esmaed coeffcens of local prces of rsk are sgnfcan. The sample means of he prces of domesc rsk are 0.48 for he US, 0.73 for Sngapore, 0.89 for he UK and 1.12 for Hong Kong. These prces of local rsk are all nsgnfcan. The robus Wald ess confrm hese resuls and sugges ha local marke rsk s no a prced facor. In shor, no evdence of segmenaon s found over hs sub-perod. One can posulae several reasons oward explanng hs ncreased sock marke negraon. Frsly, he srong economc lnks among he counres analyzed n hs sudy, especally rade and nvesmen ha have ndrecly lnked her equy markes. In fac, economc lnkages beween counres mply a comovemen n her oupu, corporae earnngs and consequenly n her capal markes, see, among ohers, Phylaks and Ravazzolo (2002,2004). Secondly, he mporan role, especally for he markes ncluded n hs sudy, of counry funds and alernave fnancal nsrumens ha provde easer access for domesc and nernaonal nvesors o naonal markes and hus ncrease her fnancal lnks wh world markes. Fnally, markes deregulaon and lberalzaon, echnologcal developmens n communcaons and radng sysems, nnovaon n fnancal producs and servces and he ncrease n he nernaonal acves of mulnaonal corporaons can furher nduce relaonshps among naonal capal markes.

8 5 CONCLUSION In hs paper, we es a parally segmened ICAPM usng an asymmerc exenson of he mulvarae GARCH process of De Sans and Gerard (1997,1998) for wo developed counres (he US and UK), wo emergng counres (Hong Kong and Sngapore) and World marke over he perod February December Ths fully paramerc emprcal mehodology, wh sgn and sze asymmerc effecs, allows o he prces of domesc and world marke rsks, beas and correlaons o vary asymmercally hrough me. The evdence shows ha hs asymmerc process provdes a sgnfcanly beer f of he daa han a sandard symmerc process. Then, we es dfferen prcng resrcons of he model over he whole perod. The evdence suppors he fnancal negraon hypohess and ndcaes ha domesc rsk s no a prced facor. Takng no accoun he fac ha fnancal negraon s an ongong process, we re-esmae he model over wo sub-perods and For he frs sub-perod, we fnd weak suppor for he hypohess ha he Hong Kong sock marke s parally segmened and hen nvesors n Hong Kong face boh common and counry-specfc rsks and prce hem boh. For he oher analysed markes, our fndngs suppor srongly he full negraon hypohess. Concernng he sub-perod , he resuls of hs paper show ha hre s no evdence of fnancal segmenaon and ha he sock markes analysed are all subjec o worlwde nfluences. REFERENCES Adler, M. and B. Dumas, Inernaonal porfolo selecon and corporaon fnance: a synhess. Journal of Fnance, 38, Aggarwal, R, B. Lucey and C. Muckley, Dynamcs of equy marke negraon n Europe: evdence of changes over me and wh evens. Pronenca. Inernaonal Symposum on Inernaonal Equy Marke Inegraon. Trny College. Dubln, jun Arshanapall, B and J. Doukas, Inernaonal sock marke lnkages: evdence from he pre- and he pos-ocober 1987 perod. Journal of Bankng and Fnance, 17, Barar, M, Inegraon usng me-varyng negraon score: he case of Lan Amerca, Inernaonal Symposum on Inernaonal Equy Marke Inegraon, Trny College, Dubln, June Barr, D. and R. Presley, Expeced reurns, rsk and he negraon of nernaonal bond markes. Journal of Inernaonal Money and Fnance, 23, Bekaer, G, Marke negraon and nvesmens barrers n emergng equy markes. World Bank Economc Revew, 9, Bekaer, G. and C. Harvey, Tme varyng world marke negraon. Journal of Fnance, 50 (2), Bekaer, G. and C. Havey, Foregn speculaon and emergng equy markes. Journal of Fnance, 55, Blson, C., V. Hooper, and M. Jauges, The mpac of lberalsaon and regonalsm upon cpal markes n emergng Asan economes. Inernaonal Fnance Revew, 1, Bollerslev, T. and J. M. Wooldrge, Quas-maxmum lkelhood esmaon and nference n dynamc models wh me-varyng covarances. Economerc Revew, 11, Carrer, F, V. Errunza and K. Hogan, Characerzng world marke negraon hrough me. Workng Paper, McGll Unversy. DE Sans, G, B. Gerard and P. Hllon, The relevance of currency rsk n he EMU. Journal of Economcs and Busness, 55, De Sans, G. and B. Gerard, Inernaonal asse prcng and porfolo dversfcaon wh me varyng rsk. Journal of Fnance, 52, De Sans, G. and B. Gerard, How bg s he premum for currency rsk. Journal of Fnancal Economcs, 49, Dumas, B. and B. Solnk, The world prce of foregn exchange rsk? Journal of Fnance, 50, Ferson, W. and C. Harvey, The rsk and predcably of nernaonal equy reurns. Revew of Fnancal Sudes, 6, Gerard, B., K. Thanyalakpark and J. Baen, Are he Eas Asan markes negraed? Evdence from he ICAPM, Journal of Economcs and Busness, 55.

9 Glosen, L., R. Jagannahan and D. Runkle, Relaonshp beween he expeced value and he volaly of naonal excess reurn on socks. Journal of Fnance, 48, Hardouvels, G, Mallaropoulos AND D. Presley, EMU and sock marke negraon. Workng Paper. Harvey, C, The world prce of covarance rsk. Journal of Fnance, 46(1), Hodrck, R. and E. Presco, Pos-War US busness cycles: a descrpve emprcal nvesgaon. Mark Wason, Federal Reserve Bank of Chcago. Huner, D The evoluon of sock marke negraon on he pos-lberalzaon perod- A look Lan Amerca. Journal of Inernaonal Money and Fnance. In press. Jeon, B. and G. Von Fursenberg, Growng nernaonal co-movemen n sock prce ndexes. Quarerly Revew of Economcs and Busness, 30, Karoly, A. and R. Sulz, Are fnancal asses prced locally or globally? Workng Paper, Oho Sae Unversy. Kroner K. and V. Ng, Modellng asymmerc comovemens of asse reurns. Revew of Fnancal Sudes, 11, Lau, S, T. and T, H. Mcnsh, Comovemens of nernaonal equy reurns:a comparson of he pre and pos-ocober 1987, perods. Global Fnance Journal, 4, Lm, K., H. Lee and K. Lew, Inernaonal dversfcaon benefs n Asan sock markes: a revs. Mmeo, Lebuan School of Inernaonal Busness and Fnance, Unvers Malasya Sabbah y Faculy of Economcs and Managemen, Unversy Puera Malaysa. Lu, Y, A. and M, S. Pan, Mean and volaly spllover effes n he US and Pacfc-Basn sock markes, Mulnaonal Fnance Journal, 1, Mash, A. and R. Mash, A Comparave analyss of he propagaon of sock marke flucuaons n alernave models of dynamc causal lnkages. Appled Fnancal Economcs, 7, Mash, A. and R. Mash, 1999.Are Asan sock marke flucuaons due manly o nra-regonal conagon effes? Evdence based on Asan emergng sok markes. Pacfc-Basn Fnance Journal, 7, Mash, A. and R. Mash, Long and shor erm dynamc causal ransmsson amongs nernaonal sock markes. Journal of Inernaonal Money and Fnance, 20, Meron, R, On esmang he expeced reurn on he marke: an explonary nvesgaon. Journal of Fnancal Economcs, 8(4), Phylaks, K. and F. Ravazzolo, Sock prces and exchange rae dynamcs. Mmeo, Cy Unversy Busness School. Phylaks, K. and F. Ravazzolo, Measurng fnancal and economc negraon wh equy prces n emergng markes. Journal of Inernaonal, Money and Fnance, 21, Phylaks, K. and F. Ravazzolo, Sock marke lnkages n emergng markes: mplcaon for nernaonal porfolo dversfcaon. Forhcomng, Journal of Inernaonal Markes and Insuons. Raanapakon, O. and S. Sharma, Inerrelaonshps among regonal sock ndces. Revew of Fnancal Economcs, 11, Roca, E. and E. Selvanahan, Ausralan and he hree lle dragons: are her equy markes nerdepeden? Appled Economc Leers, 8,

10 Table 1: Descrpve sascs of asse excess reurns Panel A: Summary Sascs Sngapore U.K. H. Kong U.S. World Mean (% per year) Mn (% per year) (dae) (Oc. 1987) (Oc. 1987) (Oc. 1987) (Oc. 1987) (Oc. 1987) Max (% per year) (dae) (Jan. 1975) (Jan. 1975) (Fab. 1973) (Oc. 1974) (Jan. 1975) Sd. Dev. (% per year) Skewness 0.51* 1.34* -0.33* 0.29** -0.39* Kuross (1) 5.38* 11.48* 2.33* 1.68* 1.22* J.B * * 98.38* 53.18* 34.35* Q(12) ** Panel B: Uncondonal correlaons of r Sngapore U.K. H. Kong U.S. World Sngapore U.K H. Kong U.S World 1.00 Panel C: Auocorrelaon of ( r ) Lag Sngapore U.K. H. Kong U.S. World ** Panel D: Auocorrelaon of ( r 2 ) Lag Sngapore U.K. H. Kong U.S. World * 0.165* ** ** ** ** ** Panel E: Cross-correlaons of ( r ) - World and Counry j Lag Sngapore U.K. H. Kong U.S * 0.695* 0.409* 0.859* ** *, ** Denoe sascal sgnfcance a he 1%and 5%, (1) cenred on 3.

11 Table 2 : Asymmerc versus symmerc model R R f 1hN d, 1 * q / 1 0, Z ; 1 exp W 1 d, 1 exp Z 1 Symmerc model CC aa 1 1 bb* Asymmerc model CC aa bb* ss* * 1 * zz * 1 1 I where I 1 f 0 oherwse I 0, I where I 1 f h oherwse 0, Panel A: Lkelhood rao es Null hypohess 2 df p-value H 0 : s z Panel B : Informaon crerons Symmerc model Asymmerc model AIC SBC Panel C: Resdual dagnoscs Sngapore U.K. H. Kong U.S. World Symmerc GARCH Mean( 100) Skewness 0.48* 1.17* -0.33** -0.34* -0.42* Kuross (1) 5.06* 10.48* 2.25* 1.61* 1.16* J.B * * 83.83* 50.66* 34.31* Q(12) Asymmerc GARCH Mean( 100) Skewness 0.46* 1.15* -0.24** -0.33* -0.42* Kuross (1) 4.92* 10.36* 2.17* 1.73* 1.15* J.B * * 82.77* 55.91* 33.89* Q(12) *, ** Denoe sascal sgnfcance a he 1%and 5%, (1) cenred on 3.

12 Table 3 : Quas-maxmum lkelhood esmaes of he parally negraed condonal ICAPM R R f CC 1h N d, 1 * q / 1 0, Z ; 1 exp W 1 d, 1 exp Z 1 aa* 1 1 bb* 1 ss* 1 1 zz* 1 1 I where I 1 f 0 oherwse I 0, I where I 1 f h oherwse 0, A: parameer esmaes-mean equaons (a) Prce of world marke rsk Cons. WDY DUSTP USDP DWIR Prce of marke rsk 0.448* (0.063) (b) Prce of domesc rsk 0.832* (0.022) ** (0.215) 0.787* ( 0.259) Cons. LDY DLIR DIP (0.416) Snga. Domesc Prce (1.456) (2.063) (0.369) (2.366) Brsh Domesc Prce (1.012) (4.414) (1.632) (2.235) Hong K. Domesc Prce (1.569) (2.855) (2.303) (3.253) Amercan Domesc Prce (0.968) (5.165) (1.588) (2.634) Panel B: parameer esmaes-mulvarae GARCH process Sngapore U.K. Hong Kong U.S. World a 0.314* (0.034) 0.206* (0.029) 0.278* (0.022) 0.225* (0.053) 0.286* (0.056) b 0.517* (0.332) s 0.112** (0.068) z (0.062) 0.753* (0.053) (0.011) ** (0.013) Panel C: Specfcaon ess Null hypohess * (0.050) 0.009* (0.003) (0.009) df 0.706* (0.083) 0.015** (0.008) ** (0.007) p-value 0.705* (0.037) (0.012) ** (0.015) Is he prce of world marke rsk consan? H0 : m, j 0 j Is he prce of Amercan domesc rsk equal o zero? H0 : dus, j Is he prce of Snga domesc rsk equal o zero? H0 : ds, j Is he prce of Hong K. domesc rsk equal o zero? H0 : dhk, j Is he prce of Brsh domesc rsk equal o zero? H0 : duk, j Are he prces of domesc rsk jonly equal o zero? H0 : d, j 0 j, k Are he s coeffcens jonly equal o zero? H 0 : s Are he z coeffcens jonly equal o zero? H 0 : z *, ** Denoe sascal sgnfcance a he 1% and 5% levels, QML sandard errors are repored n parenheses, (a) equal o 0 for he normal dsrbuon. Inorder o preserve space, esmaes of he nercep marx C s no repored.

13 Tableau 4 : Robusness ess ' / 1 Rf 1CovR, RW/ 1 d, 1VarRes / 1 Z 1, Z ; E R CC aa 1 exp W 1 d, 1 exp Z 1 * 1 1 * 1 * 1 1 * bb ss zz 1 1 I where I 1 f 0 oherwse I 0, I where I 1 f h oherwse 0, Null hypohess 2 Are counry-specfc consans all eaqual o zero? 0 H 0 : Are he local nformaon varable coeffcens jonly equal o zero? H 0 : 0 df p-value R R f CC Table 5 : Sub-sample analyss 1h N d, 1 * q / 1 0, Z ; 1 exp W 1 d, 1 exp Z 1 aa* 1 1 bb* 1 ss* 1 1 zz* 1 1 I where I 1 f 0 oherwse I 0, I where I 1 f h oherwse 0, Null hypohess df p-value 2 p-value Is he prce of world marke rsk consan? H0 : m, j 0 j Is he prce of Amercan domesc rsk equal o zero? H0 : dus, j Is he prce of Snga domesc rsk equal o zero? H0 : ds, j Is he prce of Hong K. domesc rsk equal o zero? H0 : dhk, j Is he prce of Hong K. domesc rsk consan? H0 : dhk, j 0 j Is he prce of Brsh domesc rsk equal o zero? H0 : duk, j Are he prces of domesc rsk jonly equal o zero? H0 : d, j 0 j, k

14 Fgure1 : World prce of rsk 35 ESTIMATED AVERAGE HPFILTERED Fgure 2 : Condonal correlaons wh marke porfolo 2-a Sngapore ESTIMATED AVERAGE HPFILTERED

15 2-b Uned Kngdom ESTIMATED AVERAGE HPFILTERED c Hong Kong ESTIMATED AVERAGE HPFILTERED d Uned Saes ESTIMATED AVERAGE HPFILTERED