East Asian Equity Markets, Financial Crisis, and the Japanese Currency

East Asian Equity Markets, Financial Crisis, and the Japanese Currency

Stephen Yan-leung CheungProfessor of Finance (Chair)Department of Economics and FinanceCity University of Hong Kong

July 24, 2002

East Asian Equity Markets, Financial Crisis and the Japanese Currency

2

Agenda

1. Motivations

2. Objectives

3. Data

4. Methodology and Results

5. Conclusions


3

Motivations

a. Yen/ US volatility

• Yen/ US was very volatile during the last

decade

• From 80 Yen/US to 147 Yen/US

• Yen’s depreciation reduce Asia’s trade deficit

with Japan from an annual deficit of $59 billion

in 1995-97 to $ 19 billion in 2001


4

Yen/USD movement during 1990-2002

80

90

100

110

120

130

140

150

1601/

1/90

1/1/

91

1/1/

92

1/1/

93

1/1/

94

1/1/

95

1/1/

96

1/1/

97

1/1/

98

1/1/

99

1/1/

00

1/1/

01

1/1/

02

Source: DataStream


5

Motivations

b. Interest rate differential

• Low interest rate in Japan and Yen’s

depreciation

• Yen carry trade looked lucrative


6

Interest rates in Asian countries

0

5

10

15

20

25

30

Jan-

90Ju

l-90

Jan-

91Ju

l-91

Jan-

92Ju

l-92

Jan-

93Ju

l-93

Jan-

94Ju

l-94

Jan-

95Ju

l-95

Jan-

96Ju

l-96

Jan-

97Ju

l-97

Jan-

98Ju

l-98

Jan-

99Ju

l-99

Jan-

00Ju

l-00

Jan-

01Ju

l-01

Jan-

02

Japan Discount Rate US Federal Funds Rate

HK Interbank Offered Rate: 1 Month SG Interbank Rate: 1 MonthTW Interbank Rate: Overall Weighted Average KW Call Rates: 1 to 15 Days Average


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Motivationsc. Trade deficit

• Yen’s depreciation has positive effect on Japan’s economy, e.g. reduced Asia’s trade deficit with Japan from an annual deficit of $59 billion in 1995-97 to $19 billion in 2001. (duplicated, pls refer point (a)!!!)

• Had tremendous pressure on Korean and Taiwanese exports

• On 15 June 1998, Yen hit 14 Yen/US• Finance Minister of China expressed that pressure for

a devaluation of the Yuan was growing• There was a fear of another round of competitive

devaluation.• Japan used to be a growth engine, fear on Asian

economies.


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Asian stock indices and Dollar/Yen exchange rate

0

0.5

1

1.5

2

2.5

01/95 06/95 11/95 04/96 09/96 02/97 07/97 12/97 05/98 10/98 03/99 08/99 01/00 06/00 11/00 04/01 09/01 02/02

Re

lati

ve v

alu

e o

f th

e i

nd

ice

s a

s o

f 01

/95

0

20

40

60

80

100

120

140

160

Ye

n t

o U

SD

HANG SENG INDEX NIKKEI 225 SINGAPORE STRAITS TIMES

KOREA SE COMPOSITE (KOSPI) TAIWAN SE WEIGHTED JAPANESE YEN TO US $


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Motivations Asian emerging markets, good investment

opportunities before Asian Crisis (Levy and Sarnat, 1970; Solnik, 1974)

US market, the leading market (Cha and Cheung, 1998; Cheung and Ng, 1996)

The Change in information transmission mechanism after crisis (Cha and Cheung, 1998; Tuluca and Zwick, 2001)


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Objectives 1. Study the information structure changes

between the equity markets in the US and four

East Asian economies during the Asian crisis;

and

2. Examine the impacts of Japanese currency

movements on these four East Asian economies


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DataDaily logarithmic returns: Hong Kong Korea Singapore Taiwan US

Sample period: Pre-crisis period: January 1995 – June 1997 Crisis period: July 1997 – June 2000 Post-crisis period: July 2000 – July 2001


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Methodology and results

Stationarity1. Dickey-Fuller test:

- all stock indices are I(1) processes

2. Johansen cointegration test on the indices of the US and four Asian economies :

- Pre-crisis period: pairwise cointegrated- Crisis and post-crisis period: no cointegration- Action: include an error correction term for the pre-

crisis period only


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Table 1. Unit Root Test Results

Lag ADF Lag ADF Lag ADF Lag ADFHK 7 -3.03 4 -2.94 0 -2.81 4 -2.26SG 1 -2.06 1 -2.15 0 -2.62 1 -1.76TW 0 -1.88 0 -2.39 4 -1.72 4 -0.80KW 1 -2.58 1 -2.27 0 -2.32 1 -1.82

US 0 -2.50 0 -2.74 0 -2.73 0 -1.77

Lag ADF Lag ADF Lag ADF Lag ADFHK 9 -8.87 3 -13.94 4 -7.57 3 -20.40SG 9 -7.92 0 -23.25 0 -17.00 0 -35.57TW 0 -26.52 0 -26.71 3 -9.46 3 -21.82KW 0 -22.46 0 -24.97 1 -12.42 4 -19.97

US 0 -24.77 9 -9.04 1 -12.68 2 -25.50

Panel B: First Difference of the Logarithm Indexes seriesPre-Crisis During Crisis Post Crisis Combined

Panel A: Level of the Logarithm Indexes seriesPre-Crisis During Crisis Post Crisis Combined


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Interaction patternCausality test: - decide the lead-lag relationship between 2 stock indices

Hypothesis 1: The US leads the East Asian Economies?

Xt = C + j=1,…,k jXt-j + j=1,…,n jYt-j + t where

Xt = Return on one of East Asian market indexes at time t, as measured by first log differences

Yt = the return on the US stock index - Causality: using joint significance of j's to test whether the la

gged values of Yt provide additional explanatory power for Xt after controlling for Xt's own history.


15

Interaction pattern

Hypothesis 2: The East Asian Economies lead the US?

Yt = C + j=1,…,k jYt-j + j=0,…,n jXt-j + j=1,…,m jSt-j + t

Note: Second summation index j starts from 0 instead of 1, because

the US and East Asian markets operate in different time zones

GARCH effects: - the error term and lagged dependent variables are not independent- Action:

- maximum likelihood procedure - construct the likelihood ratio statistic to test the hypothesis that js ar

e zero


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Interaction patternResults: The US leads the East Asian Economies?

- Pre-crisis period: only leads Hong Kong and Singapore- Crisis and Post-crisis period: all- Error correction term is significant in all cases

- these East Asian markets do respond to deviations from the cointegrating relationships

The East Asian Economies leads the US?- Pre-crisis period: all except Taiwan- Crisis period: all- Post-crisis period: NO- Error correction term is NOT significant


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Table 2. Causality Test Results

HK 140.56 ** 13.41 ** 117.57 ** 83.32 ** 346.88 **SG 59.13 ** 3.93 * 123.34 ** 35.60 ** 196.29 **TW 2.41 14.72 ** 51.67 ** 8.15 ** 61.66 **KW 0.93 6.64 ** 53.46 ** 32.33 ** 47.82 **

HK 8.82 ** 1.89 40.70 ** 0.90 39.89 **SG 5.66 * 2.09 19.36 ** 2.60 28.23 **TW 1.75 0.15 13.57 ** 0.80 8.21 *KW 8.78 ** 1.17 9.91 ** 0.55 9.46 **

j's = 0

j's = 0

Significance at the 10 and 5% levels indicated by 1 and 2 asterisks

j's = 0 ECT=0

j's = 0 j's = 0

j's = 0 ECT=0

j's = 0 j's = 0

Panel A: The US Causes the East Asian EconomiesPrior Crisis

Panel B: The East Asian Economies Cause the USDuring Crisis Post Crisis Entire PeriodPrior Crisis

Entire PeriodPost CrisisDuring Crisis


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Effects of the Japanese CurrencyMethodology:

- Augment with an exchange rate term

Xt = C + j=1,…,k jXt-j + j=1,…,n jYt-j + j=1,…,m jSt-j + t

Yt = C + j=1,…,k jYt-j + j=0,…,n jXt-j + j=1,…,m jSt-j + t

where

St-j = daily dollar-yen exchange rate in first log differences


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Effects of the Japanese CurrencyResults:The Japanese currency affects 4 Asian economies?- No material effects on the significance of j's and the error

correction term- Pre-crisis period: Hong Kong only- Crisis period: all- Post-crisis period: NO- Entire period: some

- yield spurious inferences about market interactions- provide erroneous information for making investment and portfolio

management decisions


20

Effects of the Japanese CurrencyRobustness of the Yen effect: Transform the equity return data from local currency uni

ts to returns in the US dollar Similar result is generated

Japanese currency as a proxy of economic condition? Include the return on the Japanese Nikkei 225 index

- to test if its presence would render the yen variable insignificant

- Result: NO


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Table 3. The Japanese Currency Effect Panel A: The US Causes the East Asian Economies

HK 134.91 ** 23.16 ** 13.23 ** 129.54 ** 16.87 ** 84.20 ** 0.96 345.27 ** 1.54SG 57.35 ** 2.16 3.90 * 129.89 ** 9.05 ** 34.94 ** 0.01 195.17 ** 0.12TW 1.86 2.98 * 13.72 ** 51.71 ** 11.10 ** 6.72 ** 2.67 63.4 ** 3.48 *KW 0.81 2.20 6.38 ** 63.14 ** 31.24 ** 32.57 ** 0.23 63.91 ** 19.04 **

Panel B: The East Asian Economies Cause the US

HK 10.67 ** 3.95 * 1.80 39.42 ** 14.29 1.16 1.05 42.76 ** 9.18 **SG 6.65 ** 3.24 * 2.06 20.56 ** 16.39 * 2.78 1.05 29.22 ** 7.43 *TW 1.67 2.00 0.06 23.41 ** 25.42 ** 0.28 0.99 8.23 * 6.93 *KW 8.53 ** 1.93 1.04 10.99 ** 16.64 * 0.83 1.25 9.25 ** 6.13

Significance at the 10 and 5% levels indicated by 1 and 2 asterisks respectively.

j's = 0

j's = 0 j's = 0

j's = 0 j's = 0

j's = 0 j's = 0 ECT=0

j's = 0

j's = 0

Prior Crisis During Crisis Post Crisis Entire Period

j's = 0

j's = 0 j's = 0

j's = 0j's = 0

j's = 0 ECT=0 j's = 0

Prior Crisis During Crisis Post Crisis Entire Period


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Conclusions Confirms the dominant role of the US market in the

East Asian equity markets Information structure during the crisis period is differen

t from the non-crisis periods. The Japanese currency is found to affect these equity

markets during the crisis period, but disappears in the post-crisis sample.


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ConclusionsImplications of the changing causal relationship : Academia:

- warrant a detailed study on information flow and propagation mechanisms under different market conditions

Investment community: - different investment strategies should be pursued under diff

erent market conditions- the use of long sample data may yield obscure and even er

roneous information on market interactions.

Thank You

Documents

East Asian Equity Markets, Financial Crisis, and the Japanese Currency