TIME-VARYING WORLD INTEGRATION OF THE MALAYSIAN STOCK MARKET: A KALMAN FILTER APPROACH

Transcription

1 ASIAN ACADEMY of MANAGEMENT JOURNAL of ACCOUNTING and FINANCE AAMJAF, Vol. 6, No. 2, 1 17, 2010 TIME-VARYING WORLD INTEGRATION OF THE MALAYSIAN STOCK MARKET: A KALMAN FILTER APPROACH Bi-Kun Yeoh 1, Chee-Wooi Hooy 2* and Zainudin Arsad 1 1 School of Mahemaical Sciences, 2 School of Managemen, Universii Sains Malaysia, USM Pulau Pinang, Malaysia * Corresponding auhor: cwhooy@usm.my ABSTRACT This paper esimaes he ime-varying world inegraion of he Malaysian sock marke and examines if he pahs of he ime-varying inegraion mach he economic evens of he counry. We employed weekly ime series daa for he period beween February 1988 and Sepember 2009 o coincide wih he liberalisaion of he Malaysian marke since he lae 1980s. To capure he ime-varying degree of marke inegraion, we employed he Kalman Filer echnique, which produces ime-varying coefficiens in esimaing Inernaional Capial Asse Pricing Model (ICAPM). The changes in he level of marke inegraion coincide wih he economic evens ha ook place in he counry and provide some evidence o he pracical applicaion and suiabiliy of he Kalman Filer echnique in sudying sock marke inegraion. Keywords: ICAPM, Kalman Filer, inegraion, ime varying coefficien INTRODUCTION Global financial inegraion has increased subsanially in recen decades. In he afermah of he Breon Woods era, globalisaion has manifesed iself among he developed counries in increasing flows of cross border capial. Globalisaion has promoed he emergence of global financial cenres (US, UK, and Tokyo) in he 1980s. In response o he reducion of various rade and financial barriers, financial inegraion subsequenly spread o he emerging markes in he early 1990s. Malaysia was one of he beneficiaries. The Malaysian sock marke, known oday as Bursa Malaysia (i was previously known as he Kuala Lumpur Sock Exchange, or KLSE), has gained Asian Academy of Managemen and Penerbi Universii Sains Malaysia, 2010

2 Bi-Kun Yeoh e. al. he fas momenum of globalisaion due o Malaysia s small bu open economy. The Malaysian sock marke is one of he bigges markes in Souheas Asia, wih a hisory sreching back abou 50 years. Before he 1990s, he Malaysian sock marke remained relaively small in erms of marke capialisaion. Due o he counry s successful indusrial ransformaion in he lae 1980s, he Malaysian economy experienced remendous growh in he early 1990s. Since hen, he Malaysian sock marke has grown remendously hanks o many liberal financial policies aimed o arac foreign capial o promoe furher growh. Bursa Malaysia has experienced high growh in erms of marke capialisaion and rading value since he early 1990s. In 1990, here were only 271 companies lised in he exchange wih a oal marke capialisaion of USD billion and USD10.70 billion in oal raded sock value. In 1996, jus before he Asian financial crisis, he number of lised companies was 618 wih a USD billion marke capialisaion; he oal value of raded socks was USD billion. The remendous growh of he marke wihin he six-year period (1990 o 1996) involved a 639% increase in marke capialisaion; he raded sock value in 1996 was 1664% of he equivalen in Given ha Malaysia was one of he hardes hi counries in he 1997 o 1998 Asian financial crisis, he number of lised companies in 1998 was 731 wih only USD95.56 billion in marke capialisaion and USD billion in raded sock value. Alhough he crisis caused a significan decrease in he value of companies as well as depreciaions in he ringgi exchange rae, he growh of Bursa Malaysia has remained significan since In 2007, he performance of Bursa Malaysia was abou he same as during he pre-asian crisis period, wih an obvious increase in he number of lised companies (986 lised companies, USD billion in marke capialisaion, and USD billion in shares raded). However, he performance of he marke was affeced by he global financial crisis in There were 976 lised companies, USD billion in marke capialisaion, and USD93.78 billion share raded in 2008, represening a sharp decrease in growh compared o 2007 (World Federaion of Exchanges, 2009). This sudy was moivaed by a number of reasons. Firs, he Malaysian economy has undergone profound srucural changes over he las few decades, evolving from a primary producer ino an increasingly diversified and broadbased economy. Malaysia can be considered one of he ypical emerging markes in he developing world. Thus, i is ineresing o see how Malaysia has inegraed wih he world marke ever since he period of liberalisaion. Secondly, mos sudies on iner-relaionships beween sock markes examine marke correlaion, long-run coinegraion or volailiy ransmission o indirecly infer he sock marke inegraion hypohesis. These approaches do no really comply wih he 2

3 Time-Varying World Inegraion definiion of marke inegraion as implied by Bekaer and Harvey (1995). Accordingly, marke inegraion has o be defined using an asse pricing model. We followed Korajczyk (1996) and Levine and Zervos (1998) o define pricing errors as he degree of marke inegraion. Thirdly, a weakness of many previous sudies was a focus on saic models ha did no consider he ime-varying naure of equiy risk premiums. For his reason, his paper employs he Kalman Filer mehodology ha allows ime-varying coefficiens of he model and hence is able o invesigae he varying degree of he Malaysian sock marke s inegraion wih he res of he world. Las bu no leas, we would like o see if his measure can esablish a link wih economic evens o confirm he pracical applicaion of he Kalman Filer approach in sudying sock marke inegraion. The res of he paper is organised as follows. In Secion 2, a brief review is provided on he issues relaed o sock marke inegraion worldwide and he approaches of assessing he level of inegraion in he lieraure. Secion 3 presens he model, he esimaion mehod and he daa used in his sudy. The esimaion resuls are presened in Secion 4, and Secion 5 provides a conclusion. LITERATURE REVIEW Bekaer and Harvey (1995) poin ou ha a marke is compleely inegraed wih he world if is asses have he same expeced reurn as he asses wih idenical risk levels lised in major global markes. In oher words, in an inegraed world, he cross secion reward o risk is no imporan, as i is common o all inegraed markes. However, he reward o risk is differen for a segmened marke due o differen risk exposures for each counry. In oher words, he law of one price can definiely work as a behaviour of sock marke inegraion. The naure and exen of financial marke inegraion is herefore prominen for invesors, as hey influence inernaional asse allocaion poenial and porfolio diversificaion decisions. The issue of iner-relaionships beween sock markes worldwide has been examined exensively using differen measures and mehodologies. In he lieraure, here are wo broad caegories of financial inegraion measures: pricebased measures and quaniy-based measures. 1 A price-based measure is more desirable for regulaors and researchers as hey prefer o refer o indicaors ha are quaniaively available. Under he price-based measure, coinegraion analysis is oday s sandard mehod in examining he long-run relaionships beween differen equiy indices. By definiion, coinegraed markes exhibi 1 See Adam, Jappelli, Menichini, Padula & Pagano (2002) and Baele, Ferrando, Hordahl, Krylova & Monne (2004) for a deailed survey of he marke inegraion research lieraure. 3

4 Bi-Kun Yeoh e. al. common sochasic rends and in urn limi he amoun of independen variaion and diversificaion opporuniies beween hese markes. 2 However, coinegraion analysis fails o ake ino accoun ha convergence is a gradual and on-going process. I only ess for convergence over he whole period under consideraion raher han invesigaing he degree of convergence ha increased more recenly han earlier in ime. Rangvid (2001) akes he effor o deec ime-varying coinegraion using a recursive mehod, bu Pascual (2003) poins ou ha he increasing convergence shown by Rangvid (2001) may be due o an increasing sample size over ime. Pascual (2003), by conducing a rolling coinegraion es wih a fixed sample size and repor, repors no evidence of increasing coinegraion among he markes. Anoher school of hough in he research lieraure focuses on he linkages beween inernaional marke indices, which includes ess on he correlaion, lead-lag and volailiy ransmissions beween markes. However, mos of he effors in his area focus on saic inegraion. Only a few have placed significan emphasis on he dynamics of inegraion over ime. Among hese, Fraser, Helliar and Power (1994), Serleis and King (1997) and Manning (2002) imply he mehodology proposed by Haldane and Hall (1991) for measuring he convergence of European equiy markes. In esing for inegraion, an exernal marke (o which he markes under sudy are assumed o be converging) and a dominan local marke need o be idenified. The principle involved in his approach is ha he coefficien of he model should approach zero if convergence wih a local marke has occurred. Bekaer and Harvey (1995) were perhaps he firs o explicily model ime variaion in expeced sock reurns induced by a changing covariance wih a single world facor. However, hey assumed ha he markes were perfecly inegraed, perfecly segmened or parially inegraed, alhough he exen of inegraion was consan over ime. There are some empirical sudies ha recognise ha coefficiens of asse pricing models should change over ime; hese sudies employ rolling regression o fix his problem. Rolling regression is a very common mehod among praciioners in producing ime-varying coefficiens. The rolling window ha covers a period of five years using monhly daa is he mos frequenly used 2 Kasa (1992) is one of he pioneers in using Johansen s (1988) mulivariae echnique o sudy long-run relaionships among he major developed markes, i.e., he US, UK, Japan, Canada and Germany markes. By using similar mehodologies, Chou, Ng and Pi (1994) found evidence of increased inegraion in he laer period under sudy for G7 counries, and Hung and Cheung (1995) provide similar findings for he Asian markes. In addiion, de Fusco, Gepper and Tsesekos (1996) found ha no coinegraing vecors exis among emerging markes like Korea, he Philippines, Taiwan, Malaysia and Thailand over he ime period from 1989 o 1993; a weak coinegraion resul is also highlighed in a laer sudy by Click and Plummer (2005). For he ASEAN-5 sock marke, Janor, Ali and Shaharudin (2007) found ha hese sock markes are boh regionally and globally inegraed. In shor, here is hardly a consensus on marke inegraion using he coinegraion approach. 4

5 Time-Varying World Inegraion window size. Korajczyk (1996), Franzoni (2001) and Hooy and Goh (2006) are among he researchers ha have used rolling regression o produce ime-varying coefficiens. However, here are few poins ha should be highlighed in he suiabiliy of he use of rolling regression. Firs, rolling regression is considered an uncondiional echnique because he coefficiens are assumed o be consan over a fixed window period ha moves forward monh by monh. In realiy, he marke inegraion level may change subsanially over a shorer period of ime, and i is essenial ha he new informaion is used o updae he coefficiens. Furhermore, by employing Ordinary Leas Square (OLS) rolling regression, one single abnormal observaion in he series will affec he esimaed coefficiens over he enire window lengh. In oher words, if he daa are rolled for a period of five years, one abnormal observaion will have he same disoring impac on all five years of he esimaed coefficiens. METHODOLOGY The Measure for Marke Inegraion The Capial Asse Pricing Model (CAPM), largely due o he work of Sharpe (1964) and Linner (1965), has become a sandard model in finance. The CAPM posulaes a sable linear relaionship beween he expeced excess reurn and he non-diversifiable risk of holding a financial asse. Under he hypohesis of sock marke inegraion, he domesic CAPM has been exended o inernaional seings, and a single facor inernaional CAPM (ICAPM) can be wrien as R R ( R R ) = 1, 2,..., N (1) i, F, i i W, F, i, where R i,, R F, and R W, refer o he reurns for he marke porfolio, world porfolio and inernaional risk free rae, respecively; represens he ime period wih sample size N; i refers o he sock markes being sudied and i, is he residual. The above menioned ICAPM assumes ha he purchasing power pariy holds, ha is, an environmen where invesors bear no currency risk and he riskreurn relaionship is unaffeced by he choice of he reference currency. While he inercep erm of he CAPM is ofen used as a measure o asses he sock selecion skills and marke iming abiliies a muual fund managers; for examples see Abdullah and Abdullah (2009) and Praher, Berin and Henker (2004), he inercep erm may also be used o examine he inergraion level of sock markes. In essence, according o Korajczyk (1996) and Levine and Zervos (1998), if a sock marke is perfecly inegraed wih he world, hen he inercep 5

6 Bi-Kun Yeoh e. al. ( i ) ha represens he pricing error should be equal o zero. Levine and Zervos (1998) proposed ha he esimaes of sock marke inegraion can be represened by he absolue value of i and muliply his value wih negaive one. In oher words, he adjused marke inegraion index can be expressed as MII i ˆ. (2) i This index is designed o be posiively correlaed wih he degree of marke inegraion. The index can ake any value wih he upper bound equal o zero, and a zero index is inerpreed as sock marke i ha is perfecly inegraed wih he world marke. OLS esimaion of Equaion (1) is sraighforward; in pracice, however, i is unreasonable o allow he level of inegraion o be consan as he risk is usually found o vary over ime. The esimaion of he ICAPM coefficiens using he OLS regression may be less desirable from economic and financial poins of view, which limis researchers in maching he levels of marke inegraion wih he economic or financial evens ha have aken place over he same period. In his sudy, we employed a ime-varying coefficien echnique o capure he imevarying marke inegraion process. Esimaing Time-Varying Inegraion wih he Kalman Filer Technique The Kalman Filer echnique allows for he esimaion of boh a ime-varying inercep and a coefficien of ICAPM. I is a recursive procedure ha progresses hrough he daa and yields a each ime a minimum mean-square linear esimae of he sae variables and a covariance marix of he esimae. The Kalman Filer approach makes use of a sae space model of (N 1) vecor of Y as a funcion of X, which is expressed by he following sysem of equaions: Y X = 1, 2,..., N (3) 1 n 1 v (4) (5) Equaion (3) is known as he observaion equaion, while Equaion (4) and Equaion (5) are called sae equaions. The equaions above can be rewrien in vecor form as Y ' Z (6) 6

7 Time-Varying World Inegraion Z AZ w, (7) 1 Where Z is a vecor of ime-varying parameers (, ), is a vecor of he consan and A is an ideniy marix. The assumed o be independenly disribued as 2 ~ IID(0, ) and w are error erms ha are and w ~ IID(0, Q ). (8) From Equaions (4) and (5), i can be noed ha boh and are allowed o vary over ime according o a random walk process. The random walk model is quie general in naure because i covers a large number of ime pahs of gradual coefficien variaion reasonably well. I also allows a gradual level shif in he parameers. 3 In his model, here are hree unknown parameers (hyperparameers) ha mus be esimaed: he diagonal elemens of Q and he 2 variance of he observaion equaion,. The Kalman Filer equaions are obained by defining Z as he vecor of he sae variables a ime and P as he covariance marix of he sae vecor. Besides ha, Z is he bes esimae of Z 1 based on informaion up o ime 1, while P is he covariance marix of Z 1. The predicion equaions are 1 expressed as Z AZ 1 1 (9) P AP 1 1A' Q. (10) In Equaion (9), he one-sep-ahead predicion of he sae is formed by aking he las known value of he variables and muliplying i by he ransiion marix A. Similarly, he esimae of he covariance marix of he sae predicion in Equaion (10) also uilises pas daa. By having he wo esimaes above, he onesep-ahead predicion error, e, and is covariance, f, can be calculaed as below: 3 Well (1994) shows he random walk model o be superior o alernaive specificaions such as Z Z 1 w in which he coefficiens are resriced o some mean values denoed by Z ; hence, he model does no allow for any level shifs. 7

8 Bi-Kun Yeoh e. al. e Y ' Z (11) 1 f 2 P '. (12) 1 The e conains new informaion abou Z beyond ha conained in Z. 1 Therefore, afer observing Y, he one-sep-ahead of he sae may be improved by incorporaing his new informaion. The updaed equaions for he esimaes of he sae and is covariance marix are expressed as Z Z P f e (13) 1 ' 1 1 P P P ' f P. (14) Then he process reurns o Equaion (9) for he nex ieraion. From he discussion above, i can been seen ha he hyperparameers of Equaion (8) are unknown and hus need o be esimaed. Under he assumpion ha and w are normally disribued, he sample log likelihood can be expressed as below o esimae he unknown parameers of he sysem equaions: nt 1 log L log 2 log f e ' f e 2 2 T T (15) The likelihood is evaluaed using he Kalman Filer esimaes and mus be maximised wih respec o he unknown parameers. By employing he Kalman Filer mehodology menioned above, he ime-invarian ICAPM of Equaion (1) can be expressed as a ime-varying ICAPM, as follows: R R ( R R ). (16) i, F, i, i, W, F, i, Hence, he saic MII of Equaion (2) aemps o be expressed via ime-series behavior as MII ˆ. (17) i, i, As can be seen in Secion 4.2, he Kalman Filer echnique ha allows for imevarying inegraion is more economically racable. The esimaed ime-varying 8

9 Time-Varying World Inegraion marke inegraion allows one o mach daa o he changing economic environmen in boh he domesic and inernaional financial markes. DATA The daa employed in his sudy are he weekly indices for he Malaysian sock marke from Morgan Sanley Capial Inernaional (MSCI). The MSCI All- Counry World Index is used as a proxy for he global porfolio, and he weekly yields on he US hree-monh reasury bill rae are used as he inernaional risk free rae. These series are in common currency, ha is, he US dollar, o alleviae any exchange rae noise. The daa covered a ime period beween February 1988 and Sepember The weekly reurns are calculaed from Wednesday o Wednesday o avoid any conaminaing effecs from Mondays and weekends, as menioned by Barholdy and Peare (2005). The compounded reurns of he indices, R, is calculaed as follows: R CP log 100 CP 1 (16) where CP is he Wednesday closing price on week. RESULTS AND DISCUSSION Descripive Saisics and Uni Roo ess Table 1 summarises some saisical properies for he reurns for he Malaysian and world sock markes. From Table 1, i can be noed ha he mean reurns for Malaysia are slighly higher han he reurns for he world marke. However, he sandard deviaion ha measures he risk of a sock marke shows ha he risk for Malaysia is abou wo imes higher han ha of he world marke. This is no surprise because he emerging marke is expeced o be more unsable and volaile compared o he world marke, which includes he developed sock markes. Furhermore, he difference beween he minimum and maximum values of he reurns for he Malaysian sock marke is much larger han ha of he world marke. On op of ha, boh Malaysian and global reurns show a negaive sign of skewness, indicaing ha he reurn series are skewed o he lef; herefore, he probabiliy of obaining a profi in each rading week is higher. The kurosis values for boh series are larger han he value for he normal disribuion of hree, suggesing ha he uncondiional disribuion of he reurn is no 9

10 Bi-Kun Yeoh e. al. normally disribued. The disribuions are lepokuric relaive o he normal disribuion. Table 1 Descripive Saisics Minimum Maximum Mean Sd. Dev. Skewness Kurosis Malaysia World Prior o modelling he daa, he Phillips-Perron (PP) and Augmened Dickey-Fuller (ADF) ess were carried ou o deermine he uni roo propery of he daa. Boh ess were performed on he excess reurns of he Malaysian porfolio, R i, R F, and excess reurns of he world porfolio, R W, R F, because he ICAPM is expressed in erm of excess reurns. The uni roo ess were performed wih inerceps and wo alernaives of rend assumpions, ha is, wih and wihou rend. From he abulaed resuls in Table 2, i can be noed ha he series are saionary due o he rejecion of he null hypohesis of uni roo a a 5% significan level for boh he ADF and PP ess. Thus, he series can be used for subsequen analysis. Table 2 ADF and PP Uni Roo Tess of Excess Reurns of he Malaysian and World Porfolios Series Lag Wihou rend ADF Lag Trend Lag 10 Wihou rend PP Lag Trend R i, R F, R W, R F, Noe: 1 denoes significance a he 5% level Esimaion of Marke Inegraion Before we proceed o he ime-varying Kalman Filer model, we firs esimae he saic coefficiens from he OLS regression, which could serve as a useful benchmark for he average value of he dynamic ime-varying coefficien produced by he Kalman Filer. The resul from esimaing Equaion (1) by OLS is repored in Table 3. I can be noed ha he inercep erm is no significanly differen from zero a he 5% level. This resul implies ha he ICAPM is wellspecified for he daase. When convering he daa according o he marke inegraion index formula ( MII ˆ ), he Malaysian sock marke is shown o be quie inegraed wih he world markes, wih he convered MII value

11 Time-Varying World Inegraion equalling However, his ime-invarian assumpion migh be invalid as he risk premium of equiies is indeed ime-varying, and herefore, he degree of marke inegraion will also be ime-varying in naure. Table 3 Resuls from he Ordinary Leas Square esimaion Variable Coefficien -Saisic (0.1145) RW, RF, (0.0528) Noes: 1 he value of MII is given by, ha is, denoes significance a he 5% level; sandard errors are given in parenheses We proceeded o employ he Kalman Filer approach o examine he imevarying naure of he marke inegraion index. The ime-varying coefficien MII from he Kalman Filer model is ploed in Figure 1, accompanied by he MII value obained from OLS and he corresponding OLS confidence inervals. 4 From Figure 1, we can see ha he OLS confidence inervals fail o indicae he presence of srong variaions of he marke inegraion index as suggesed by he sae-space model. Furhermore, looking a he esimaed MII from boh mehods, he value of MII from he OLS esimaion, i.e., , is very differen from he average of MII, i.e., Hence, i is no surprise ha he dynamics of MII are no capured by he OLS confidence inervals. The ime-varying MII generally flucuaed around zero, excep for a disorion during he 1997 o 1998 Asian financial crisis. The sae of inegraion is obviously affeced by economic evens. In many occasions, he flucuaion of MII is quie consisen wih he world and regional crises and he chronology of he developmen of he Malaysian sock marke. In he subsequen discussion, we provide a deailed analysis of he consisency of he dynamics of MII wih he developmen of Bursa Malaysia over he las wo decades. 4 In line wih Brooks, Faff and Mckenzie (1998) and Hearn (in press), he firs wo years of he esimaed MII values were no aken ino consideraion in he resuls ha are repored in his paper due o he naure of he Kalman Filer approach ha generaes a very large (and some cases negaive) esimaion a he iniial sages. The exclusion of firs wo year esimaions can avoid any biases due o his sar-up problem. 11

12 Bi-Kun Yeoh e. al. The Chronology of Marke Inegraion The liberalisaion of he early 1990s I is obvious ha he values of MII have an increasing rend from 1990 o This resul indicaes ha he Malaysian equiy marke was becoming more inegraed wih he world marke during his period, which was acually he saring poin of sock marke liberalisaion in Malaysia. In he pas, Malaysia has been relucan o relax foreign ownership resricions in he financial secor. However, wih he view ha opening he financial secor o foreign insiuions will inroduce inernaional sandards of bes pracices and also increase compeiiveness, Malaysia gradually recognised he imporance of opening up he domesic financial secor o foreign compeiion. In he lae 1980s o 1990, he Malaysian governmen ook some acion o reform he capial markes. Their iniiaions included easing he enry barriers o he brokering aciviies of foreign insiuions, increasing he number of muual funds and allowing foreign sock brokerage firms o increase heir equiy share in local brokerage firms from 30% o 49%. On op of ha, in March 1991, Malaysia issued RM190 million in bonds ha were converible ino shares of sae-owned communicaions firms. This acion marked he firs placemen of a converible sovereign bond in he inernaional marke. Addiionally, a Malaysias fund was launched on he New York Sock Exchange (NYSE) in December 1987, wih a ne asse value of USD98.3 million in December These facors may explain he fas inegraion of he Malaysian equiy marke wih he world marke in his early period. The capial conrol in 1994 Saring from January of 1994, he Malaysian governmen adoped some capial conrol measures o curb shor-erm capial inflows. The governmen announced ha residens were prohibied from selling cerain kinds of Malaysian securiies o nonresidens. Examples of hese insrumens were negoiable insrumens of deposi, Bank Negara bills, Malaysian governmen reasury bills and Malaysian governmen securiies wih a remaining mauriy of one year or less. Furhermore, in February of 1994, Briish firms were prevened from paricipaing in public secor conrac bidding, and residens were prohibied from selling any form of privae deb securiies wih a remaining mauriy of one year or less o non-residens. The resricions on he sale of Malaysian securiies o nonresidens were exended o boh he iniial issue of he relevan securiy and he subsequen secondary marke rade. Figure 1 shows ha he MII sared o decrease even before he announcemen of capial conrol measures and achieved is lowes poin when such conrols sared o be implemened in January of

13 Time-Varying World Inegraion The resricion on he sale of Malaysian securiies was lifed and residens were permied o sell any Malaysian securiies o non-residens in Augus of In addiion, he Malaysian cabine lifed is seven-monh ban prevening Briish firms from paricipaing in public secor conrac bidding. As expeced, he degree of inegraion of he Malaysian marke wih he world marke increased afer his aboliion of capial inflow. According o he model, he Malaysian marke began o be paricularly inegraed wih world marke from February of 1995 o April of 1997, as he MII is close o zero during his ime period. Figure 1. Time-varying Marke Inegraion Index using he Kalman Filer Approach and Confidence Inervals of OLS esimaion. 5 Asian financial crisis in he lae 1990s In May of 1997, speculaors aacked he Thai Bah, and he devaluaion of he Thai Bah on July 2, 1997, se off a massive meldown of he foreign currency markes in he region. The exchange rae crisis led o he collapse of he sock markes in he ASEAN 5, Korea, Japan and Hong Kong. The foreign direc invesmen (FDI) in Malaysia fell a an alarming rae, and he ringgi depreciaed subsanially from MYR 2.50 per USD o a much lower level (up o MYR 4.80 per USD a is lowes poin) as significan capial flowed ou. Alhough he Asian crisis spilled ino he global marke as well, he exen of vulnerabiliy for he res of he world was much lower compared o he eigh aforemenioned counries mos affeced by he crisis. This explains why he Malaysian sock marke was significanly segmened from he world marke from July of 1997 o Augus of 5 A a 95% confidence level, he OLS confidence inervals are wrien as (MII * sandard error). Hence, he OLS confidence inervals in Figure 1 are given by: OLS CI = ( *0.1145) = ( , ) 13

14 Bi-Kun Yeoh e. al The level of inegraion of Malaysia o world markes umbled o an allime low in Augus of On Sepember 1, 1998, he exchange rae of he ringgi o he US dollar was fixed a 3.8 RM/USD, and a wide range of currency and capial conrols were insiued. Foreign invesors were prohibied from wihdrawing funds from Malaysia for a one-year period saring in Sepember of However, hey were allowed o wihdraw saring from mid-february of 1999 afer paying a scaled exi ax ha favoured long-erm invesors. The capial conrol measures have conribued o he recovery of he sock marke. Many foreign porfolio invesors were araced o Malaysia by hese very capial conrols, alhough hey may once have condemned hem soon afer hey were firs inroduced in Sepember of From he foreign invesors poin of view, Malaysia offers a porfolio invesmen haven ha is relaively shelered from he volailiy of global capial markes. Addiionally, foreigners locked in unil Sepember 1, 1999, have wihdrawn heir funds from he banks ha offered low ineres raes o ake advanage of he sock marke s upurn afer he grea deph o which he Malaysian sock marke fell during he Asian financial crisis. This clarifies why he MII rose sharply afer he ringgi was pegged agains he US dollar. Pos Asian financial crisis era and he world financial crisis of he lae 2000s According o he saisics in Masud e al. (2008), Malaysia remained a favourable economy o foreign invesors as implied by he FDI posiion ha grew from MYR129.1 billion in 2001 o MYR253.8 in The coninuous reinvesmen, as well as new capial injecion among he exising foreign companies, indicaed heir confidence in he invesmen climae of Malaysia. I can be noed ha he abandonmen of he fixed exchange rae regime in July 2005 did no have any obvious impac on he level of inegraion. The US marke experienced a subprime crisis a he end of 2006 and 2007, and he crisis sared o spread o he developed European counries. During ha period, he financial markes in Malaysia were less affeced due o he small direc exposure o he subprime-relaed markes. Therefore, he MII in 2007 was slighly lower compared o he previous year. However, he downside pressures on he US economy and furher downurns in he US housing secor have sared o develop ino global economic shocks. The rising uncerainy and concerns over he problems in he global financial markes and he healh of he global economy led o increased volailiy in he regional equiy markes, especially owards he end of he year. Saring from January of 2008, he increase in MII owards zero indicaes Malaysia s high degree of inegraion wih he world markes. Malaysia, as an emerging counry, is ineviably influenced by his global crisis. This phenomenon is very differen 14

15 Time-Varying World Inegraion from he 1997/98 Asian financial crisis, in which he Malaysian sock marke was obviously segmened from he world marke during he crisis. CONCLUSION This sudy examines he degree of sock marke inegraion of he Malaysian sock marke wih he world markes over he ime period ranging from February 1988 o Sepember The ime-varying Kalman Filer echnique was employed o capure he dynamic degree of he sock marke inegraion. Unlike prior sudies ha only showed he degree of inegraion among counries ha changes over ime, his paper aemped o explain he varying degrees of inegraion wih he economic evens ha have aken place. Generally, he findings show ha he capial reform and capial conrol measures ha were imposed by he Malaysian governmen have affeced he levels of inegraion of he Malaysian sock marke wih he global marke. Furhermore, he resuls show ha he Malaysian sock marke was segmened from he world marke during he 1997 o 1998 Asian financial crisis bu is now more closely inegraed wih he world marke during a ime of global crisis. ACKNOWLEDGMENT We are graeful for he financial suppor from Universii Sains Malaysia Fellowship and he Research Universiy Posgraduae Research Gran (Gran number: 1001/PMATHS/832059). REFERENCES Abdullah, N. A., & Abdullah, N. A. H. (2009). The performance of Malaysian Uni Trus invesing in domesic versus inernaional markes. Asian Academy of Managemen Journal of Accouning and Finance, 5(2), Adam, K., Jappelli, T., Menichini, A., Padula, M. & Pagano, M. (2002). Analyse, compare, and apply alernaive indicaors and monioring mehodologies o measure he evoluion of capial marke inegraion in he European Union. Ialy: Universiy of Salerno. Baele, L., Ferrando, A., Hordahl, P., Krylova, E. & Monne, C. (2004). Measuring financial inegraion in he Euro Area. European Cenral Bank Occasional Paper, no. 14. Frankfur am Main: European Cenral Bank. 15

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