Stock Market Integration Measurement: Investigation of Malaysia and Singapore Stock Markets

Authors: B. K. Yeoh, Z. Arsad, C. W. Hooy

Abstract:

This paper tests the level of market integration between Malaysia and Singapore stock markets with the world market. Kalman Filter (KF) methodology is used on the International Capital Asset Pricing Model (ICAPM) and the pricing errors estimated within the framework of ICAPM are used as a measure of market integration or segmentation. The advantage of the KF technique is that it allows for time-varying coefficients in estimating ICAPM and hence able to capture the varying degree of market integration. Empirical results show clear evidence of varying degree of market integration for both case of Malaysia and Singapore. Furthermore, the results show that the changes in the level of market integration are found to coincide with certain economic events that have taken placed. The findings certainly provide evidence on the practicability of the KF technique to estimate stock markets integration. In the comparison between Malaysia and Singapore stock market, the result shows that the trends of the market integration indices for Malaysia and Singapore look similar through time but the magnitude is notably different with the Malaysia stock market showing greater degree of market integration. Finally, significant evidence of varying degree of market integration shows the inappropriate use of OLS in estimating the level of market integration.

Keywords: ICAPM, Kalman filter, stock market integration.

Digital Object Identifier (DOI): doi.org/10.5281/zenodo.1062784

References:

[1] G. Bekaert and C. R. Harvey, "Time varying world market integration," Journal of Finance, vol. 50, pp. 403-444, 1995.
[2] K. Adam, T. Jappelli, A. Menichini, M. Padula and Pagano, M., "Analyse, compare, and apply alternative indicators and monitoring methodologies to measure the evolution of capital market integration in the European Union," Report commissioned by the European Commission, 2002.
[3] L. Baele, A. Ferrando, P. Hordahl, E. Krylova and Monnet, C., "Measuring financial integration in the Euro area," European Central Bank Occasional Paper 14, 2004.
[4] K. Kasa, "Common stochastic trends in international stock markets," Journal of Monetary Economics, vol. 29, pp. 206-217, 1992.
[5] S. Johansen, "Statistical Analysis of Cointegration Vectors," Journal of Economic Dynamics and Control, vol. 12, pp. 251-254, 1988.
[6] R. Chou, V. Ng and L. Pi, "Cointegration of international stock market indices," IMF Working Paper, WP/94/94, 1994.
[7] B. Hung and Y. Cheung, "Interdependence of Asian equity markets," Journal of Business,Finance and Accounting, vol. 22, pp. 281-288, 1995.
[8] R. de Fusco, J. Geppert, and G. Tsetsekos, "Long run diversification potential in emerging stock markets," The Financial Review, vol. 31, pp. 343-363, 1996.
[9] R.W. Click and M.G. Plummer, "Stock market integration in ASEAN after the Asian financial crisis," Journal of Asian Economics, vol. 16, pp. 5-28, 2005.
[10] J. Rangvid, "Increasing convergence among European stock markets? A recursive common stochastic trends analysis," Economics Letters vol. 71, pp. 383-389, 2001.
[11] A.G. Pascual, "Assessing European stock markets (co)integration," Economics Letters, vol. 78, pp. 197-203, 2003.
[12] P. Fraser, C.V. Helliar and D.M. Power, "An empirical investigation of convergence among European equity markets," Applied Financial Economics, vol. 4, pp. 149-157, 1994.
[13] N. Manning, "Common trends and convergence? South East Asian equity markets, 1988-1999," Journal of International Money and Finance, vol. 21, pp. 183-202, 2002.
[14] A. Haldane and S. Hall, "Sterling-s relationship with the dollar and the deutschemark 1976-1989," Economic Journal vol. 101, pp.436-443, 1991.
[15] W. Sharpe, "Capital asset prices: A theory of market equilibrium under conditions of risk," Journal of Finance, vol. 19, pp. 725-742, 1964.
[16] J. Litner, "The valuation of risky assets and the selection of the risky investments in stock portfolios and capital budget," Reviews of Economics and Statistics, vol. 47, pp. 13-37, 1965.
[17] R.A. Korajczyk, "A measure of stock market integration for developed and emerging markets," World Bank Economic Review, vol. 10, pp. 267- 289, 1996.
[18] R. Levine and S. Zervos, "Stock markets, banks, and economic growth," American Economic Review, vol. 88, pp. 537-558, 1998.
[19] R.E. Kalman, "A new approach to linear filtering and prediction problems," Journal of Basic Engineering, vol. 82, pp. 35-45, 1960.
[20] R.E. Kalman and R. Bucy, "New results in linear filtering and prediction theory," Journal of Basic Engineering, vol. 83, pp. 95-108, 1961.
[21] J. Bartholdy, and P. Peare, "Estimation of expected return: CAPM vs. Fama and French," International Review of Financial Analysis, vol. 14, pp. 407-427, 2005.
[22] R.D. Brooks, R. W. Faff and M.D. Mckenzie, "Time-varying beta risk of Australian industry portfolios: A Comparison of Modeling Techniques," Australian Journal of Management, vol. 23, pp. 1-22, 1998.
[23] B.A. Hearn, "Development strategy in offshore markets: Evidence from the Channel Islands," Journal of Economic Studies, forthcoming, 2009.
[24] G. Bekaert and Harvey, C.R., "Capital flows and the behavior of emerging market equity returns," NBER Working Paper, w6699, pp. 1- 77, 1998.
[25] M.R. Masud, Z.M. Yusoff, H.A. Hamid and N. Yahya, "Foreign direct investment in Malaysia - findings of the quarterly survey of international investment and services," Journal of the Department of Statistics, Malaysia, vol. 1, pp. 1-9, 2008.
[26] K. Phylaktis and R. Fabiola, "Measuring financial and economic integration with equity prices in emerging markets," Journal of International Money and Finance, vol. 21, pp. 879-903, 2002.