Bond Market Integration in East Asia: A Multivariate GARCH with. Dynamic Conditional Correlations Approach +

Transcription

1 Preliminary draf Bond Marke Inegraion in Eas Asia: A Mulivariae GARCH wih Dynamic Condiional Correlaions Approach + by Yoshihiko Tsukuda*, Junji Shimada**, and Tasuyoshi Miyakoshi*** Ocober, 203 JEL Classificaion: Key Wards: Eas Asian Bond markes, Bond Marke Inegraion, Dynamic Condiional Correlaion + An earlier version of his paper was presened a Singapore Economic Review Conference 203 in Augus 203, Singapore. * Graduae School of Economics and Managemen, Tohoku Universiy ** School of Business, Aoyama Gakuin Universiy *** Faculy of Science and Engineering, Hosei Universiy Correspondence: Tasuyoshi Miyakoshi, Faculy of Science and Engineering, Hosei Universiy 3-7-2, Kajino-cho, Koganei, Tokyo, , Japan. el: , [email protected]

2 Absrac: This sudy analyzes how and wha degree he emerging Eas Asian local bond markes are inegraed wih he global bond marke, he Japanese bond marke and he inra-regional cross-border bond markes by applying he DCC-GARCH model o he local currency bond yield indices. Alhough he local currency bonds ousanding in he Eas Asian markes have been grealy enhanced during he firs decade of he 2s cenury, our resuls reveal ha inegraion of he local bond markes on he exernal markes remains a he low level for ASEAN-4 (Indonesia, Malaysia, he Philippines and Thailand), Souh Korea, and China. Hong Kong and Singapore are more inegraed wih he global marke raher han he inra-regional cross-border bond markes. The effecs from he Japanese marke o he emerging Eas Asian markes are minimal. 2

3 . Inroducion One of he major reasons for 997 Asian financial crisis was he excessive dependence of he Asian economies on commercial banks for domesic financing. The region failed o diversify is sources of corporae financing as i relied mainly on banks since is oher ypes of available financing, namely bond markes, were sill underdeveloped and small. Furhermore, he peg-currencies o he US dollar minimized he currency risks for boh borrowers and lenders. This encouraged foreign capial inflow excessively. On he oher hand, he Asian corporae secor borrowed shor-erm foreign currency loans from commercial banks, which hey used for financing heir long-erm domesic invesmen. When deb service on shor erm loans maured bu credi dried up, hese corporae borrowers were no able o borrow capial from heir ousanding invesmens. As defaul cases increased, i became more difficul and more expensive o borrow credi. As capial ouflow coninued, he currency depreciaed and his worsened he abiliy of corporae firms and banks o pay since heir deb in local currency had risen significanly. Thus, Asian economies faced he double mismach problem. (Io (2007), Bhaacharyay (203)). Based upon he above undersanding, Eas Asian counries individually made persisen effors o develop more efficien and sable financial sysems and also collecively progressed dialogues o cooperae hrough he regional financial iniiaives. The mos imporan iniiaives are regional economic surveillance processes in he Associaion of Souheas Asian Naions (ASEAN) and ASEAN+3 (ASEAN plus China, Japan, and Souh Korea), he Chiang Mai Iniiaive, he Asian Bond Markes Iniiaives, and he Asian Bond Fund Iniiaive. The region ook he opporuniy o deepen marke-led inegraion and policy-induced cooperaion and also promoed cross-border financial ransacions hrough financial marke deregulaion and capial accoun liberalizaion. There have been many sudies on hese iniiaives and he developmen of bond markes, for example, Kawai (2007), Spiegel (20), Felman e al. (20) among ohers. Thanks o he boh individual and collecive policy endeavors, he bond markes in he Eas Asian counries have seadily progressed in erms of ousanding volumes during he pas fifeen years afer he Asian financial crisis of 997. Despie he regional financial marke developmen, he inegraion of he emerging Eas Asian bond markes seems insufficien. Several sudies also sugges relaively weak inraregional link among Asian financial markes compared wih heir global links (Kim e al. (2008), Park and Lee (20)). I is imporan o undersand he degree and dynamics of financial inegraion in emerging Asia no only for economic growh and developmen, bu also for financial sabiliy. Financial inegraion, in heory, offers many benefis, such as beer consumpion smoohing hrough inernaional risk sharing, more efficien allocaion of capial for invesmen, and enhanced macroeconomic and financial discipline. However, igher financial linkages also generae a higher risk of cross-border financial conagion in pracice. (Eichengreen (2006)). A projec under he ABMI published a comprehensive wo volume repor o foser sandardizaion of marke pracices and harmonizaion of regulaions relaing o cross-border bond ransacions in he region. See ASEAN+3 Bond Marke Guide published by ADB(202). 3

4 The purpose of his paper is o examine how and wha degree he emerging eas Asian bond markes are inegraed wih exernal markes 2. Mos of he pas researches invesigaed he insiuional and hisorical aspecs of bond markes in he region wih only a few excepions. Plummer and Click (2005) reviewed he developmen and level of inegraion for he bond markes in he Associaion of Souheas Asian Naions (ASEAN). Johansson (2008) examined he condiional correlaions beween he limied numbers of he Eas Asian markes. Park and Lee (202) convincingly argue he problems on inegraion of he emerging Asian local bond marke as well as sock marke among he inra-regional and global markes. For analyzing he local currency bond yield indices, we apply a mulivariae GARCH model which is now commonly used for assessing he degree of co-movemens in asse prices among differen markes. Engle (2002) proposed a dynamic condiional correlaion model. This model and is exended models are now widely used for analyzing he asses markes such as Bauwens e al.(203), Grier and Smallwood (203), Conner and Suurrlah (203), and Syllignakis and Koureas (203) among ohers. Skinzi and Refenes (2006) examined he dynamic linkages among he European bond markes. They model he price and volailiy spillovers from he US bond marke and he aggregae Euro area bond marke o welve individual European bond markes using an EGARCH model ha allows for a dynamic correlaion srucure. Our sudy builds upon he mehodology developed by Skinzi and Refenes (2006), more specifically, analyzes he degree of dependencies in he emerging Eas Asian local bond markes on he global bond marke, he Japanese bond marke and he inra-regional cross-border bond markes. The resuls reveal ha he dependency of he local bond markes on he exernal markes remains a he low level for ASEAN-4 (Indonesia, Malaysia, he Philippines and Thailand), Souh Korea, and China, implying inegraion of he emerging Eas Asian bond markes are limied. However, Hong Kong and Singapore are more inegraed o he global marke raher han he inra-regional cross-border bond markes. The effecs from he Japanese marke o he emerging Eas Asian markes are minimal. Our resul confirms Park and Lee (20) while we employ saisically more coheren mehod han hey did. Furher effors boh individual and collecive are expeced o deepen he bond marke inegraion. The paper is organized as follows. Secion 2 briefly reviews a developmen in he emerging Eas Asian bond markes during he las decade. Secion 3 provides an economeric mehodology o examine quaniaively he degree of inegraion of each of he emerging Asian local bond marke on he global marke, he Japanese marke, and he inra-regional cross border markes in a saisically coheren manner. Afer saing he daa descripion and preliminary analyses in Secion 4, Secion 5 indicaes he empirical resuls. Secion6 gives some concluding remarks. 2. Inegraion of he Emerging Eas Asian Bond Markes 2 Emerging Eas Asia in his paper denoes Indonesia, Malaysia, he Philippines, Singapore, Thailand, China, Souh Korea, and Hong Kong. 4

5 There exiss no unanimously agreed definiion of he erm inegraion of he financial markes. In his paper, regional inegraion means a process ha leads o greaer inerdependence wihin a region, wheher marke-driven or policy-led or a combinaion of boh. Global inegraion refers o a similar process operaing globally. Regional inerdependence indicaes regional economic ineracion hrough invesmen, finance, and oher channels. The degree of inerdependence affecs he way of a region s economies move ogeher and how changes are ransmied among hem 3. Fully inegraed financial markes can be seen as a siuaion in which raders can ransac financial asses freely wihin an area. To gauge he exen of financial inegraion, we have basically wo measures: volume and price measures. This secion briefly provides an overview of he emerging Eas Asian bond markes such as he size of bonds ousanding in comparison wih he world oal, and bond marke developmen for he recen years afer he Asian financial crisis. Thereafer, we show cross-border holdings in he region, which provides some evidence on financial inegraion. In laer secions, we analyze price measures yields co-movemens in deail. Table shows he local currency (LCY) bonds ousanding in he world s major bond markes. The share of emerging Eas Asia s LCY bonds in he world s oal has reached 8.8% in March 202, which surpasses hose of France (5.2%), Germany (3.8%), and he Unied Kingdom (2.7%). China and Korea coninued o be he larges bond markes in he region apar from Japan, accouning for 5.% and.9%, respecively, of he global oal. Emerging Eas Asia LCY bonds have become an indispensable asse class for global invesors. Table. The Local Currency Bonds Ousanding in he World s Major Markes Figure (a) illusraes he LCY bond ousanding in he emerging Eas Asian markes of eigh counries since he end of December Wih he regional effors, as well as individual counries commimens, he bond markes have grown rapidly, more han seven imes since 2000, reaching $6.5 rillion in 202. The size of China is larges and more han half of he oal size. Then, Korea and Hong Kong follow. ASEAN five come las. The LCY bond markes can play alernaive channel for financing in he region in addiion o he banking sysem. Figure (b) indicaes he LCY bond ousanding relaive o GDP. The relaive size measured by he raio o GDP exhibis differen prospecs. Korea and Malaysia are grouped as highes counries, while China says raher lower group. Mos counries have increased he raio hrough he periods. Figure. LCY Bonds (USD billions) Ousanding in he emerging Eas Asia 3 See Asian Economic Inegraion Monior (202) for he definiion of inegraion. 5

6 Figure 2(a) and (b) illusraes he LCY corporae bond ousanding in he emerging Eas Asian markes of eigh counries since he end of December China s raio is small hough he size of bond ousanding is iself is larges because of he scale of he economy. The corporae bond markes have also expanded more han six imes since The speed of expansion was acceleraed in Korea and China. The relaive size of he corporae bonds ousanding o he oal bonds is approximaely one hird. The oher wo hirds are governmen bonds. Figure2. LCY corporae Bonds (USD billions) ousanding in he emerging Eas Asia Coordinaed Porfolio Invesmen Survey (CPIS) repors daa on inernaional porfolio asse holdings by providing a breakdown of a counry s sock of porfolio invesmen asses by he issuer s counry of residency available annually since Figure 3(a) indicaes inra-regional cross-border deb securiies invesmen from each of he Eas Asian counries seen from he offer side. Inra-regional cross-border holdings of eigh Eas Asian counries of Hong Kong, Singapore, Japan, Thailand, Malaysia, Korea, Philippines, and Indonesia amoun o 300 USD billion. The daa for China is no available. Hong Kong and Singapore are he larges counries, and Japan comes nex. The volumes of inra-regional cross-border holdings have seadily increased during he las elven years. The speed of growh was acceleraed afer he global financial crisis. This speed acceleraion is more clearly observed from Figure 3(b). For example, Gong Kong goes up from 8% in2009 o 42% in 20. The average raio of inra-regional cross-border invesmen over he region excep for Japan goes up from 22 % o 34% for he same period. This implies ha he bond markes in he emerging Eas Asia have developed inegraion seadily during he las decade in erms of he volume of cross-border bond holding. Figure.3 Inra-regional Cross-Border Deb Securiies Invesmen from Each of he Eas Asian Counries: Seen from Offer Side 3. Economeric Mehodology This secion provides an economeric mehodology o examine quaniaively he dependencies of each of he emerging Asian local bond marke on he global marke, he Japanese marke, and he inra-regional cross border markes in a saisically coheren manner. Le us consider a Gaussian vecor auoregressive (VAR) model wih a finie order for an n-dimensional vecor ime series ',,, n, Y y y : 4 The CPIS daabase provides informaion on economies year end cross-border holdings of porfolio invesmen securiies. See Coordinaed Porfolio Invesmen Survey Guide, second ediion by IMF (2002). 6

7 p Y A AY, =,, T, () 0 i i i for fixed values of Y p,..., Y and Y 0, X is a d-dimensional exogenous variables vecor, and is an n-dimensional error erm. Le L denoe he lag operaor and define make he following assumpion. Assumpion : In he VAR model of (), we assume ha i ( L) I A L. We (i) rank () r, 0 r n, so ha () can be expressed as () wih and boh n r marices of full column rank r; (ii) he characerisic equaion ( ) 0 has n - r roos equal o and all oher roos ouside he uni circle. n i p i Assumpion implies ha he process Y is an I() process wih coinegraion of order r. The columns of n r marix span he space of coinegraing vecors, and he elemens of denoe he corresponding adjusmen coefficiens. Defining he difference operaor L, we have he vecor error correcion model (VECM) represenaion: p Y Y Y X (2) i i i where ' and p i A j ji ( i =,, p- ). The error erm follows a mulivariae GARCH model wih dynamic condiional correlaion (DCC) proposed by Engle (2002) as N ~, H, 0 where denoes he informaion se up o ime -. The condiional variance covariance marix ( H ) is facorized ino he produc of variance and correlaion marices: H D R D, D diag h,, h and R, 2 2, nn, (3) where D is a diagonal marix of variances, and R is an n x n correlaion marix. The condiional variance of he i-h elemen follows as a univariae GARCH (, ) model h h for i=,, n. 2 ii, i0 i i, i ii,- (4) Using normalized error erm vecor u D 2, 7 (5)

8 he condiional correlaion marix of is given by ' R E( uu I ). We specify an innovaion of he condiional correlaion marix as Q a b Q bq au u ' - (6) where Q is an overall mean of Q. Then, we can obain he relaion R Q 2 2 diag q,, q diag q,, q., n n,, n n, The i, j elemen of R can be wrien as ij, ij, 2 = q q q ii, jj, a b q bq au u ij ij,- i, j, 2 2 a b qii bqii,- au i, a b q j, j bq j, j,- au j, (7) 2 We noe ha he correlaion coefficiens are nonlinear funcions of wo unknown parameers a and b. The covariance beween he i-h and j-h elemens is expressed accordingly as h h h 2. (8) ij, ij, ii, jj, Le denoe he full se of parameers for boh he mean equaions and for he mulivariae DCC-GARCH specificaion. Based on a sample of size T, he log-likelihood funcion becomes ( ;,, ) log(2 ) logde( ). (9) 2 T ' L Y Y n H H We use he maximum likelihood mehod o esimae he parameers of, afer deermining he number of coinegraion relaions and he order of he VAR model in (2). In he nex secion, we apply his DCC- GARCH model wih four variables for analyzing dependency of each emerging Eas Asian local marke on he exernal markes. 4. Daa Descripion and Preliminary Analysis We assess how much he emerging Eas Asian local bond marke is inegraed wih he global bond marke, he Japanese bond marke, and he inra-regional cross border emerging Eas Asian markes by using he bond yields index daa. We suppose ha he bond yield movemens are driven by four level hierarchical chocks in he one way direcion. The global shocks spread o he Japanese marke, he inra-regional cross-border Eas Asian markes (hereafer referred o (aggregaed) regional marke), and he local markes. The shocks occurred in he Japanese marke affec o he aggregaed regional marke and local markes. The shocks in he regional marke will affec he local markes. The conagion is one-way direcion: Global o Japan o regional and o local markes, bu no reverse 8

9 way. This assumpion is reasonable for he purpose of his paper. 4. Daa Descripion Daa of his sudy consiss of weekly bond yields indices from eigh emerging Eas Asian counries and Japan and he Unied Saes. Emerging Asia in his paper includes ASEAN-5 (Indonesia, Malaysia, he Philippines, Singapore, and Thailand), PRC, Souh Korea, and Hong Kong. The daa are sampled weekly (Wednesday-o-Wednesday) over he period from January 200 o 3 December 202 wih sample size of 628. Daa for emerging Eas Asia are aken from Asia Bonds Online published by Asian Developmen Bank (ADB). The bond yield indices for he USA, and Japanese markes are approximaed by he yields on he en year mauriy governmen bond. The USA bond marke is regarded as he global marke in his paper. We employ he following noaions: Rk, : Y ield on he bond index of he k-h local mrke a ime R EA k, : Yield on he aggregae regional markes, which is defined by yield on he inra-regional cross-border emerging Eas Asia marke for he k-h local marke a ime ; m EA ( k ) k, j, j, j, k R w R, where ( k ) w GDP GDP and GDP j, is he gross j, j, l, l, k domesic produc (GDP) of he j-h counry a ime. 5 G J R, R : Yields respecively on he global and Japanese bond marke index a ime. Figure 4 (a) o (c) indicaes he yields on he bond indices. "Asia" in he figure denoes he GDP-weighed average yields over he eigh emerging Eas Asian markes which are shown in each panel as a benchmark for he convenience of comparison. From visual inspecion, we observe some characerisics: (i) Bond yields in all markes change over ime. (ii) Emerging Eas Asian local markes are classified ino hree groups according o he level of yields in recen years afer he global financial crisis of 998/99: low yield markes (Hong Kong and Singapore), middle yield markes (Korea, Malaysia, Thailand and China) and high yield markes (Indonesia and he Philippines). (iii) The series of bond yields for he mos markes seem o have endency converging o he ranges from 2 o 6% poins, while degree of flucuaions are amplified during he periods of he Global Financial Crisis from 2008 o 2009 for many markes. m Figure 4. Yields of Bond Indices 5 This idea of making an aggregae regional index appears in Skinzi and Refenes (2006).They exclude he yield of he marke under consideraion in order o focus only on shocks ha are exernal o he specific local marke. 9

10 Table 2 indicaes descripive saisics for he log difference of yields. The sylized facs for he asse reurns such as weakly significan skewness, high kurosis, srongly significan auocorrelaion of squared yields process are observed from Table 2. Table 3 shows he conemporaneous uncondiional correlaions of log-difference yields among he differen markes. The eigh emerging Eas Asian local markes are ordered according o he magniudes of correlaion wih he global marke. Hong Kong and Singapore are among he highes markes, Philippines and Indonesia are he lowes ones, and he remaining counries fall in he middle range. All he counries grouped by he uncondiional correlaion coincide wih hose classified by he yield level in Figure 4. I is noeworhy ha China has very small correlaion wih he global markes even hough he size of bond ousanding is exremely large among he emerging Eas Asia. Table 2: Descripive Saisics for he Log Difference Bond Yields Table 3: Conemporaneous Uncondiional Correlaions among Bond Markes 4.2 Uni Roo Tess and Coinegraions Tess Before apply he mulivariae GARCH model for he LCY bond yields, we have o check he saionariy of ime series daa, and furher es wheher coinegraion relaions exis among he bond yield series if no saionary. Table 4 indicaes he Augmened Dickey Fuller (ADF) es for uni roo. All of ime series of he yields follow he inegraed of order one I() excep for Malaysia. Table 4: Uni roo ess We analyze he yields by using he model in Secion 2 wih four variables for each local marke G J EA k, k, defyingy log R, log R, log R, log R. We specify he model p ' i i i ' Y Y Y, ~ N0,, (0) and es he hypohesis H0: rank ( ) r vs H: rank ( ) 4, by using he Johansen s race es 6. The lag-lenghs are deermined by he SIC (Schwarz Informaion Crierion). Table 5 indicaes ha he lag-lengh is p = 2, and here is no coinegraion relaion for all he local markes. Table 5: Coinegraion esss 6 Sricly speaking, neiher he ADF nor Johansen s es are no applicable because he DCC-VECM does no saisfy he assumpion of i.i.d. normal disribuion for he error erm. However, we ignore hese aspecs in his paper for simpliciy. See Seo (999, 2007) for more in deail. 0

11 5. Empirical Sudy 5. Parameer Esimaes and he Condiional Correlaions Based on preliminary analysis in he previous subsecion, we esimae he VAR model μ Y ε, ε - ~ N 0H Y,, () wih equaions (4) and (7). The esimaes of parameers are shown in Table 6. The parameers of 4, 42, 43, and 44 in he las row of indicae he coefficiens for he emerging Eas Asia local marke in he equaion () 7. of 4 4 The resuls in Table 6 reveal he following findings: (i) All he esimaes for he GARCH erms,, are highly significan, for he DCC erms of a and b are also srongly significan excep for he parameer of a in Malaysia. This resul implies ha he DCC-GARCH specificaion makes sense for he yields of he emerging Eas Asian bond markes. (ii) The effecs of global markes ( 4) on he mean of he local marke are significan for all he emerging Eas Asia excep for Indonesia and China. The increase of yield of he previous period in he global marke has posiive effec on he yield in his period for he mos local markes. Excepions are Indonesia and China. In paricular, China is no affeced from he global marke since is -value is very small in absolue value. (iii) The Japanese effec ( 42) is significan only for Singapore and are insignifican for all oher counries. The Japanese bond marke does no much cause he yields movemen in he merging Eas Asian markes. (iv)the aggregaed regional effecs ( 43) are significan for he five markes ou of he eigh markes. The markes of Korea, Singapore, Thailand, Philippines, and Indonesia are significan, bu Hong Kong, Malaysia and China are no. (v) China is very differen from oher emerging markes. The bond yields of China depend only on is previous value bu no on oher markes even hough is ousanding value is more han half of he emerging Eas Asia. This may reflec ha China imposes sric conrols on he capial flows, so ha he openness of China bond marke is low. Table 6: Esimaes of Parameers Nex, we consider he condiional correlaions beween he k-h emerging Eas Asia local for j = 4 j, h4 j, hjj, h44,, ( marke and he global, Japanese, and regional markes expressed by k ) ( k ) ( ) ( ) k k 2, 2, and 3 respecively. Figure 5(a)-(c) indicae he average condiional correlaions over he 7 Esimaes of oher parameers are omied for he save of space.

12 subgroups of individual emerging Asia s markes, namely for j =, 2, and 3, m ( k ) 4 j, 4 j, m k where m denoes he number of counries wihin he subgroup. The markes are again classified ino he same groups as in Figure 4 according o he characerisics of condiional correlaion: (i) The markes of Hong Kong and Singapore are highly correlaed wih all exernal markes for all he periods. The correlaions wih he global marke are sronges among he hree groups, and are always higher han 0.4. The second sronges one is he Japanese marke. The regional marke comes las, bu sill more han 0.2 for mos periods. (ii) For he middle yield markes of Korea, China, Malaysia and Thailand, he siuaions are quie differen from he low yields markes. The correlaions are weaker han hose of he low yield markes in general. The levels in he regional markes are comparable o he global marke. The correlaions wih Japan are weakes and almos zero for mos periods. (iii) For he high yield markes of Indonesia and Philippines, he correlaions are always less han 0.2 hough he regional markes are sronges among he hree. Figure 5. Averaged Condiional Correlaions ( k ) The condiional correlaions of includes no only he direc relaion beween he wo 4 j, variables bu also he indirec relaions hrough oher variables. For example, includes no only ( k ) 43, he specific relaion beween he k-h individual marke and he inra-regional cross border markes bu also he indirec effecs hrough he global marke and he Japanese marke. Hence, i is imporan o single ou he effec specific o each of he sraified level of global, Japan and regional markes. 5.2 The effecs of exernal shocks from he global, Japan and regional markes on he shocks of local marke This subsecion assesses how much he shocks of he emerging Eas Asian local bond marke depend on he shocks from he global, Japan, regional, and specific local markes. This assessmen is meaningful for measuring he degree of inegraion of he local markes o he exernal markes. We assume ha he conagion of shocks is one-way direcional down from he global marke o he Japanese marke, he regional marke, and finally o he local marke, bu do no go reverse way. We do no consider he oher way of conagion in his paper. The above assumpion may be jusified because he emerging Eas Asian bond markes were newly developed relaive o he maured markes such as he USA and Japanese bond markes. The riangular facorizaion of he condiional covariance marix in Appendix A provides a building block for he following discussion. We decompose he shock in he local marke ino a weighed sum of he independen shocks occurred in he global, Japan, regional and local markes by applying he riangular facorizaion o he condiional variance covariance marix ( ) H k : 2

13 L L L, (2) ( k) ( k) ( k) ( k) ( k) ( k) ( k) ( k) 4, 4,, 42, 2, 43, 3, 4, where,,, and indicae he independen random shocks in each level of he ( ) ( ) ( ) ( ), 2, 3, 4, markes 8. The coefficien L ( k ) 4 j, represens he degree of sensiiviy o he specific shock in he j-h exernal marke. We have wo alernaive measures for assessing he relaions among he emerging Eas Asian local bond marke and he exernal markes: condiional correlaion ( k ) and sensiiviy ( k L ).The 4 j, 4 j, former shows a simple correlaion beween 4, and j, condiional on he informaion up o ime -, so ha includes he indirec relaions hrough oher variables. On he oher hand, he laer measures a pure relaion beween 4, and j, afer removing he indirec effecs from he previous variables of,,, j, condiional on he informaion up o ime -. Hence, hese wo measures are no necessary same concepually as well as numerically. The riangular facorizaion in (2) has an alernaive inerpreaion. Le us define he vecor of error erm as (,,, ) (,,, ), for he k-h emerging Eas ( k) ( k) ( k) ( k) ( k) ' ( k) ( k) ( k) ( k) ' G, J, EA, k,, 2, 3, 4, Asian local marke. The expecaion of ( k ) 4, condiional on,, and is given by ( ) ( ) ( ), 2, 3, E,, L L L. (3) ( k ) ( k ) k ( ) ik ( ) k ( ) k ( ) k ( ) k ( ) k ( k ) ( ) 4,, 2, 3, 4,, 42, 2, 43, 3, ( ) ( ) ( ) The shocks of k, k, and k represen he global shock, he Japanese specific shock afer, 2, 3, removing he indirec effecs hrough global shock, and he inra-regional cross border specific shock afer removing he global marke and Japanese marke shocks. Then, ( k ) ( k ) ( k ) ( k ) ( k ) ( ik ) 4, 4, 4,, 2, 3, E,, is inerpreed as a predicion error and an inrinsic shock o he local marke. Figure 6 draws he graphs of sensiiviy of he local marke o he j-h exernal facor L for j =, 2, and 3 averaged over he subgroups. By comparing Figure 6 wih m ( k ) 4 j, L4 j, m k 8 The idea of explaining he local shock by he global and regional shocks appears in Park and Lee (20). Bu hey failed o decompose he local shocks o muually independen facors. 3

14 Figure 5, we observe he following facs: (i) The wo measures of dependency give differen values for some of he local bond markes. For he low yield markes, he sensiiviy o he global marke ( L 4, ) in he panel (a) is he larges one among he hree sensiiviies for mos of he periods, bu is very close o ha of he regional marke ( L 43, ) for he periods of afer he global financial crisis in The sensiiviy o he Japanese markes is he smalles one. On he oher hand, he condiional correlaion measure for he low yiled markes give he Japanese marke ( 42, ) higher posiion han he regional marke ( 43, ). (ii) The regional sensiiviy ( L 43, ) plays relaively sronger roles in Figure 6 han he condiional correlaion ( 43, ) do in Figure 5. (iii) The Japanese marke plays a minimal role among he hree exernal markes in erms of sensiiviy measure. This fac implies ha he effec of he Japanese markes on he emerging Eas Asian local markes is indirec hrough he global marke. (iv) The sensiiviies o he global marke is highes for he high yield counries, bu become weaker as he levels of yields are geing decrease. The sensiiviy o he regional markes is highes for he lowes yield counries, and is geing decrease as he yields become higher. Figure 6. Averaged Sensiiviies of he Individual Markes o he Exernal Shocks 5.3 Conribuion of he Global, Japanese and Regional Markes on he Volailiy of he Local Marke We invesigae how much he global, Japanese and regional markes conribue o he volailiy of he local marke. Applying (A.6) in Appendix A, he condiional variance of he emerging Eas Asian local marke is decomposed ino he weighed sum of condiional variances of he independen random variables h Var( )= (4) ( k) ( k) ( k) ( k) ( k) ( k) 44, 4,, 2, 3, 4, ( ) ( ) 2 ( ) where k, =( k 4, ) ( k j L j Var j, ) for j =, 2, 3, 4, and L ( k ) 44,. The relaive conribuions of each facor in he righ hand side o he oal variaion of he local marke are evaluaed by = h ). We noe ha *( ) ( ) ( ) j, j, 44, +. *( k) *( k) *( k) *( k), 2, 3, 4, Figure 7 denoes he relaive conribuion of each facor o he individual volailiy * m *( k ) j, j, m k averaged over he subgroups. 4

15 The resuls reveal he following facs: (i) The local marke specific facor is dominan and higher han 60% for all he emerging Eas Asian markes and for all he ample periods ( * 4, ). (ii) The conribuions of he global facor are relaively large in he low yield markes (Hong Kong, Singapore), while hose in he middle and high yield markes are less han 0 % for all he periods. (iii) The Japanese conribuions are negligible for all he local markes. (iv)the regional facor conribues approximaely 0 % in he middle yield markes. These observaions imply ha he inra-regional inegraion sill remains a he low level, while some markes such as Hong Kong and Singapore are inegraed o he global marke he inra- regional markes. Furhermore, we do no observe any clear upward rends in he bond marke inegraion. Table 5 shows he relaive percenage conribuions of he exernal facors o he volailiies of he individual local markes averaged over he sample periods. We find ha: (i) Hong Kong and Singapore bond markes are highly inegraed o he global markes. China, Indonesia and Philippines are no inegraed o any exernal markes. (ii) The regional inegraions are a low level. Figure 7. Averaged Relaive Conribuions of Exernal facors o he Volailiy of individual local markes Table 7. Average conribuions of foreign facors o he individual volailiy 5.4 Implicaions The LCY bond ousanding in he emerging Eas Asian markes rapidly developed during he pas fifeen years afer he Asian financial crisis of 997. The share of emerging Eas Asia s LCY bonds in he world s oal in 202 surpasses hose of he advanced European bond markes such as France, Germany, and he Unied Kingdom. Emerging Eas Asia LCY bonds are now an indispensable asse class for global invesors. Regional inegraion means a process ha leads o greaer inerdependence wihin a region, wheher marke-driven or policy-led or a combinaion of boh. Inegraion could enhance he developmens of bond markes in he region. The volumes of inra-regional cross-border holdings seadily increased during he las elven years of our sample period, in paricular afer he global financial crisis. The emerging Eas Asia deepened inegraion in erms of cross-border holdings. However, invesigaion in his paper by using he DCC-GARCH model clarifies ha inegraion is sill limied in erms of price co-movemens or yield co-movemens excep for Hong Kong and Singapore. Hong Kong and Singapore are inegraed more wih he global marke han wih he regional markes. Our resul confirms Park and Lee (20) while we employ saisically more coheren mehod han hey did. In order o foser he bond marke inegraion, furher effors boh individual and collecive are required. 6. Conclusions This sudy examined how and wha degree he emerging Eas Asian local bond markes are 5

16 inegraed wih he global bond marke, he Japanese bond marke and he inra-regional cross-border bond markes by applying he DCC-GARCH model o he local currency bond yield indices. Triangular facorizaion of he condiional variance covariance marix played a key role o define a measure of assessing he dependency of he local marke on each of he above exernal markes. Alhough he bond ousanding in he Eas Asian markes have been grealy enhanced during he firs decade of he 2s cenury, he empirical resuls reveal ha he dependency of he local bond markes on he exernal markes remains a he low level for ASEAN-4 (Indonesia, Malaysia, he Philippines and Thailand), Souh Korea, and China. This implies ha inegraion of he emerging Eas Asian bond markes is limied. However, Hong Kong and Singapore are more inegraed o he global marke raher han he inra-regional cross-border bond markes. The effecs from he Japanese marke o he emerging Eas Asian markes are minimal. Furher effors boh individual and collecive are expeced o pu forward he bond marke inegraion. While we focused on he analysis of he emerging Eas Asian local bond markes, he mehod in his paper is readily applied o he sock markes in he region. Several modificaions and exensions of he analysis in his paper are fairly sraigh forward. (i) In addiion o he invesigaion in his paper, we can furher go o examine he impulse-response behavior of he local markes. (ii)an alernaive mulivariae GARCH model of BEKK formulaion proposed by Engle and Kroner (995) o DCC model migh be ineresing because he BEKK model is more flexible han he DCC. (iii) I is worh o examine wheher he condiional variance and covariance of he pas periods affec he yields of he presen ime as Grier and Smallwood (203) did in a differen conex. (iv) Maekawa and Seiawan (202) proposed an alernaive esimaion mehod of generalized leas squares (GLS), which is free from he normaliy assumpion for he disribuion of error erms and seems o be robus agains deviaion from he normaliy assumpion. Hence, he GLS mehod of esimaion migh be promising o ry. However, hese sudies are lef for fuure researches. 6

17 References: Asian Developmen Bank (202), Asian Economic Inegraion Monior July 202, Manila, Philippines. Asian Developmen Bank (202), Asia Bond Monior, November 202, Manila, Philippines. Asian Developmen Bank (202), ASEAN+3 Bond Marke Guide, Manila, Philippines. Asian Developmen Bank (203), Asian Bonds Online, Manila, Philippines, Available a hp://asianbondsonline.adb.org/regional/abm.php Azis, I. J., S. Mira, A. Baluga, and R. Dime (203), The Threa of Financial Conagio o Emerging Asia s Local Bond Markes: Spillovers from Global Crises, ADB Working Paper No. 06. Bauwens, L., C. M. Hafner and D. Pierpe (203), Mulivariae Volailiy Modeling of Elecriciy Fuures, Journal of Applied Economerics, 28, pp Bhaacharyay, B.N. (203), Deerminans of bond marke developmen in Asia, Journal of Asian Economics, 24, Chan, E., Chui, M., Packer, F. and Remolona, E. (202), Local Currency Bond Markes and he Asian Bond Fund 2 Iniiaive, BIS Pare No Eichengreen, B. (2006), The Developmen of Asian Bond Markes, in Asian Bond Markes: Issues and Prospecs, BIS Papers, No. 30. Engle, R. F. (2002), Dynamic Condiional Correlaion A Simple Class of Mulivariae GARCH Models, Journal of Business and Economic Saisics, 20 (3), pp Engle, R., and Kroner, K. (995), Mulivariae Simulaneous GARCH, Economeric Theory,, Felman, J., S. Gray, M. Goswami, A. Jobs, M. Pradhan, S. Peiris and D. Senevirane, (20), ASEAN5 Bond Marke Developmen: Where Does i Sand? Where is i Going?, IMF Working Paper, WP//37. Grier, K. B. and A. D. Smallwood (203), Exchange rae Shocks and Trade: A Mulivariae GARCH-M Approach, Journal of Inernaional Money and Finance, 37, pp Hamilon, J. D. (994), Time Series Analysis, Princeon Universiy Press. Inernaional Moneary Funds (2002), Coordinaed Porfolio Invesmen Survey Guide, Second Ediion Io, T (2007), Asian currency crisis and he inernaional moneary fund, 0 years laer: Overview, Asian Economic Policy Review, 2, Johansson, A.C. (2008), Inerdependencies among Asian bond markes, Journal of Asian Economics, 9, 0 6 Kawai, M. (2007), Asian Bond Marke Developmen: Progress, Prospecs and Challenges, Key Noe Speech, High Yield Deb Summi Asia Singapore. Lee, H.W., Xie, Y.A. and Yau, J.(20), The impac of sovereign risk on bond duraion: Evidence from Asian sovereign bond markes, Inernaional Review of Economics and Finance, 20, Kim, S. and J. W. Lee (202), Real and Financial Inegraion in Eas Asia, Review of Inernaional Economics, 20(2), Maekawa, K., and K. Seiawan,(202), Esimaion of Vecor Error Correcion Model wih GARCH Errors, Proceeding on SMU-ESSEC Symposium on Empirical Financeial Economerics, 8-9 June 202, Singapore. Park, C. Y. and J. W. Lee (20), Financial Inegraion in Emerging Asia: Challenges and Prospecs, Asian Economic Review Policy, 6,

18 Plummer, M. G., and Click, R. W. (2005), Bond Marke Developmen and Inegraion in ASEAN2, Inernaional Journal of Finance and Economics, 0, Seo, B.(999), Disribuion Theory for Uni Roo Tess wih Condiional Heeroskedasiciy, Journal of Economerics 9, Seo, B.(2007), Asympoic Disribuion of he Coinegraing Vecor Esimaor in Error Correcion Models wih Condiional Heeroskedasiciy, Journal of Economerics 37, 68. Skinzi,V. D. and A. N. Refenes (2006), Volailiy Spillovers and Dynamic Correlaion in European Bond Markes, Journal of Inernaional Financial markes, Insiuions & Money, 6, Spiegel, M. M. (202), Developing Asian Local Currency Bonds Markes: Why and How, in Implicaion of he Global Financial Crisis for Financial Reform and Regulaion in Asia, edied by Kawai e al., Edward Elgar, UK and USA, Syllignakis, M. N. and G. P. Koureas (203), Dynamic Correlaion Analysis of Financial Correlaion: Evidence from he Cenral and Easern European Markes, Inernaional Review of Economics and Finance, 20,

19 Appendix A: Triangular Facorizaion of a Posiive Definie Symmeric Marix and Transformaion of Normal Random Variables This appendix explains riangular facorizaion of a posiive definie symmeric marix. Then his facorizaion is used for ransforming he random variables ino a se of independen ' random variables. Le x ( x,, x n ) be an n-dimensional normal random vecor wih zero mean and a nonsingular covariance marix A: x N(0, A ), where A An A. (A.) An A nn Then here exiss a unique riangular facorizaion such ha ' A L L (A.2) where L is an upper riangular marix wih diagonal elemens of ones and D is a diagonal marix; 0 0 L2 L, and diag(,, n) 0 Ln Lnn (A.3) We ransform he random vecor x ino a new random vecor ' x ( x,, xn) L x or equivalenly x Lx. (A.4) Then, he covariance marix of x is Var( x) implying ha is elemens are independen each oher. The i-h elemen of x is a linear combinaion of independen random variables (,, ) ; x x i xi L i x L iixi x, i (A.5) and is variance is decomposed ino he weighed sum of variances of independen random variables x i s Var( x )=( L ) ( L ). (A.6) The condiional expecaion of is given by 2 2 i i ii i i xi on ( x,, xi ) E,, = Hence, xi xi E xi x,, xi x x x L x L x. (A.7) i i i ii i is inerpreed as a predicion error. Equaion (A.5) is a minimum variance predicor of x i. See Hamilon (994), for insance, for explicily deriving each elemen of L and, proving uniqueness of he riangular facorizaion in (A.2), and opimaliy of he predicor in (A.5). 9

20 Table. Local Currency Bonds Ousainding in Major Markes: End-March 202 (US$ billion) LCY Bonds Ousanding % of World Toal Unied Saes 26, Japan, France 3, Germany 2, Unied Kingdom, Emerging Eas Asia 5, of which China 3, of which Korea,290.9 of which ASEAN Source: Asia Bond Monior, November 202 Noe: ASEAN-5 refers o he five larges economies of he ASEAN: Indonesia, Malaysia, he Philippines, Singapore, and Thailand. 20

21 Table.2 Descripive Saisics for he Log Difference of Bond Yields Mean Sd.Dev Skew Kur Min Max Q(4) Q(4)-2 Global * 08.8* Japan * 45.* Asia * 293.9* Hong Kong * Singapore * Korea * Thailand * 76.5* Malaysia * 40.* China * 58.* Philippines * 8.9* Indonesia * Noe : "Asia" denoes GDP-weighed average yields over he eigh emerging Eas Asian markes. Q(4) denoes he Ljung-Box Saisics wih lag of 4 for he log-difference process and Q(4)-2 denoes hose of squared process. The criical value of Q(4)-saisic a 5% significance level is 9.49, and "*" in Q es denoes 5% significance. Table.3 Conemporaneous Uncondiional Correlaions among Bond Markes GLO JPN HOK SG KOR THA MAL PRC PHI IND Global.00 Japan HongKong Singapore Korea Thailand Malaysia China Philippines Indonesia Noe: The eigh emerging Eas Asian local markes are ordered according o he magniudes of correlaion wih he global marke. 2

22 Table.4 ADF Tess for Uni Roo ADF es Level s Difference Global Japan HongKong Singapore Korea Thailand Malaysia -3.56* China Philippines Indonesia Noe : For yields of each he local marke, we specify he model as p μ i i ε, ε ~ 0 2., i y y y N The ADF saisic ess he hypohesis H0: 0 vs H: 0. Similarly we carry ou he ADF ess for he log-differences of he yields. The criical poin of ADF es is a 5% level. The lag lenghs are deermined by he SIC (Schwarz Informaion Crierion). 22

23 Table.5 Coinegraion Tess Lag p- = 0 p- = p- = 2 p- = 3 p- = 4 Hong Kong SIC * Trace es(r=0) p-value (0.60) (0.70) (0.768) (0.729) (0.82) Singapore SIC * Trace es(r=0) p-value (0.2) (0.389) (0.483) (0.305) (0.607) Korea SIC * Trace es(r=0) p-value (0.626) (0.958) (0.977) (0.963) (0.976) Thailand SIC * Trace es(r=0) p-value (0.487) (0.74) (0.696) (0.605) (0.696) Malaysia SIC * Trace es(r=0) p-value (0.376) (0.68) (0.562) (0.645) (0.649) China SIC * Trace es(r=0) p-value (0.037) (0.480) (0.64) (0.689) (0.80) Philippines SIC * Trace es(r=0) p-value (0.76) (0.464) (0.43) (0.389) (0.538) Indonesia SIC * Noe : We specify hevecm as p Trace es(r=0) p-value (0.090) (0.549) (0.63) (0.67) (0.858) Y Y Y, ~ N0,, i i i and es he hypohesis H0: rank ( ) r vs H: rank ( ) 4 in order o deermine he number of coinegraion relaions for each of lag lenghs of p = o 5 by using Johansen s race es. The es deermines r = 0 for all he markes and for all p = o 5 excep for only wo markes of China and Indonesia wih p =, for which r =. The SIC is calculaed based on he number of coinegraions deermined by he hypohesis ess. The * denoe he smalles SIC. The enry in parenhesis indicaes p-value. 23

24 Table.6 Esimaes of Parameers a b HongKong (6.23) (-.2) (0.97) (-0.78) (8.97) (68.83) (3.54) (63.76) Singapore (4.36) (-2.4) (2.54) (-0.5) (6.85) (04.2) (3.30) (84.46) Korea (6.6) (-0.07) (2.23) (-0.39) (7.33) (8.74) (4.03) (58.49) Thailand (3.86) (.90) (3.48) (3.79) (22.0) (83.38) (3.0) (68.45) Malaysia (2.60) (-0.28) (.7) (2.46) (20.42) (42.82) (.49) (26.42) China (0.44) (0.47) (-0.95) (6.96) (7.53) (8.2) (2.74) (54.97) Philippines (2.09) (0.97) (3.57) (-.40) (32.03) (2.83) (4.64) (77.66) Indonesia (-.58) (.52) (2.55) (3.52) (0.28) (20.25) (2.52) (4.00) Noe : The esimaed VAR model is Y μ Y ε, ε - ~ N0, H. The parameers of 4, 42, 43, and 44 respecively indicae he coefficiens for he emerging Eas Asia local marke in he above equaion (2). The -values are in parenhesis. The aserisks of 4, 42, 43, and 44 denoe significance a he 5% level. All he esimaes of 4, 4, a and b are highly significan excep for he esimae of a in Malaysia. 24

25 Table.7 Averaged Relaive Conribuions of Exernal Facors o he Emerging Asian Individual local markes Global Japan Regional Local HongKong Singapore Korea Thailand Mlaysia China Phiolippines Indonesia Noe : Numerical values indicae he averaged relaive conribuions over T k k he sample periods : for j = Global, Japan, regional and j j, T local facors and for each of he emerging Eas Asian local markes. 25

26 USD bilion % 40 Source: Asian Bonds Online Figure. LCY Bonds Ousanding in Emerging Eas Asia (a) Size of he Markes (b) Raio o GDP ASEAN HongKong Korea China China Korea HongKong Singapore Thailand Malysia Philippines Indonesia 26

27 Figure 2. LCY Corporae Bonds Ousanding in Emerging Eas Asia (a) Size of he Markes USD bilion ASEAN HongKong Korea China (b) Raio o GDP % China Korea HongKong Singapore Thailand Malysia Philippines Indonesia Source: Asian Bonds Online 27

28 Figure.3 Inra-regional Cross-Border Deb Securiies Invesmen from Each of he Eas Asian Counries: Seen from Offer Side (a) Amouns of Invesmen USD millions Thailand, Malaysia, Korea, Philippines, Indonesia Japan Singapore Hong Kong (b) The Raio of Inra-regional Cross-Border Invesmen o he Toal Cross-Border Invesmen for Each Counry and he Region (%) Hong Kong Indonesia Korea Malaysia Philippines Singapore Thailand Japan Region Region ex. Japan Source: Coordinaed Porfolio Invesmen Survey (CPIS) repors, IMF. Noe: Eas Asian region consiss of Hong Kong, Singapore, Japan, Thailand, Malaysia, Korea, Philippines, Indonesia, and China. The daa for China is no available. 28

29 % Figure.4 Yields of Bond Indices (a) Low Yield Markes (Hong Kong, Singapore) 0 0/0 0/03 0/05 0/07 0/09 0/ % (b) Middle Yield Markes (Korea, China, Malaysia, and Thiland) /0 0/03 0/05 0/07 0/09 0/ Global Japan Asia HongKong Singapore Asia Korea Thailand Malaysia China 25 % (c) High Yield Markes (Philippines, Indonesia) Asia Philippines Indonesia 5 0 0/0 0/03 0/05 0/07 0/09 0/ Noe : "Asia" denoes he GDP-weighed average yields over he eigh emerging Eas Asian markes considered in his paper. The yields of Asia are shown in each panel as a benchmark for he convenience of comparison. 29

30 0.8 Figure.5 Averaged Condiional Correlaions of he Local Marke wih Global, Japan and Regional Markes ( 4 j,) (a) Averages over Low Yield Markes (Hong Kong, Singapore) /0 0/03 0/05 0/07 0/09 0/ (b) Averages over Middle Yield Markes (Korea, China, Malaysia, and Thiland) /0 0/03 0/05 0/07 0/09 0/ (c) Averages over High Yield Markes (Philippines, Indonesia) 0.6 Global Japan Regional Global Japan Regional Global 0 Japan -0.2 Regional /0 0/03 0/05 0/07 0/09 0/ Noe: for j Global, Japan, and Regional; indicae he m ( k ) 4 j, 4 j, m k averaged condiional correlaions over he subgroups. 30

31 Figure.6 Averaged Sensiiviies o he Exernal Shocks ( L ) (a) Averages over Low Yield Markes (Hong Kong, Singapore) 4j, Global Japan Regional /0 0/03 0/05 0/07 0/09 0/ (b) Averages of Middle Yield Markes (Korea, China, Malaysia, and Thiland) /0 0/03 0/05 0/07 0/09 0/ (c) Averages of High Yield Markes (Philippines, Indonesia) Global Japan Regional Global Japan Regional /0 0/03 0/05 0/07 0/09 0/ Noe: L m ( k ) 4 j, L4 j, m k for j Global, Japan, and Regional; indicae he sensiiviies o he exernal shocks averaged over he subgroups 3

32 Figure.7 Average Relaive Conribuions 00% 80% 60% 40% 20% (a) Averages over Low Yield Markes (Hong Kong, Singapore) 0% 0/0 0/03 0/05 0/07 0/09 0/ 00% 80% 60% 40% 20% (b) Averages over Middle Yield Markes (Korea, China, Malaysia, and Thiland) 0% 0/0 0/03 0/05 0/07 0/09 0/ Regional Japan Global Regional Japan Global 00% 80% 60% 40% 20% (c) Averages over High Yield Markes (Philippines, Indonesia) 0% 0/0 0/03 0/05 0/07 0/09 0/ Noe: The relaive conribuion of each facor o he volailiy of individual local marke is given by m * *( k ) j, j, for j Global, Japan, Regional, and m k Inrinsic local markes averaged over he subgroups. Regional Japan Global 32