Dynamic financial linkages among the Asia Pacific economies: an empirical assessment of real interest parity condition

Real Interest Parity (RIP) has been considered as the necessary rule to justify the exchange rates regime and the extent of financial integration among countries. This study of RIP condition is particularly important for the Asia Pacific economies that have undergone a series of currency crisis and financial turmoil. We incorporate three major analyses that cover the post liberalization period prior to the Asia financial crisis (1984-1997). First, we investigate the dynamic linkages of real interest rates among ASEAN-5 economies. Second, we assess the behavior of real interest differentials of Japan-ASEAN. Third, we examine the additional transmission channels of real interest rates from the US, Hong Kong, South Korea and Taiwan. Our findings suggest that there have been substantial integration among the ASEAN-5 and the East Asian with both the US and Japanese capital markets. However, the US-dominant hypothesis is more recognized. In addition, most countries are found vulnerable to external shocks and there is less monetary autonomy given that Asian economies have converged speedy to their equilibrium rates following the impulse from the US and the Japanese real interest rates. To great extent, our empirical evidence supports the recent proposal of common currency area as an alternative regime, not only to fight against systemic failures or monetary instability, but also to avoid the macroeconomic trilemma.Real interest parity, mean reversion, half-life, financial integration, common currency

International Parities among China and Her Major Trading Partners in Asia Pacific

As China’s role in world economy has steadily grown, her importance to the international trading and finance has also increased apace. A joint investigation of the international parity conditions for China and her thirteen major trading partners in Asia Pacific is thus conducted. Monthly observations and sub-samples within 1986-2007 are being considered to accentuate the effects of institutional changes and financial crisis. Advanced econometric procedures including the heterogeneous panel and endogenous break tests for unit root and correction factor model for half-life estimation are utilized in the analyses. Our findings reveal that first, endogenous and exponential breaks are confirmed for the real exchange and real interest differential series, which mostly occur in 1988, 1993/94 and 1997/98. Second, RIP holds better than PPP, suggesting the greater financial integration than trade integration among APEC-China. The undervalued exchange rate regime may exert some drawbacks against the PPP theorem. Third, both parities tend to hold better in the post-liberalization and post-crisis era, attributed not only to the financial liberalization process among APEC economies, but also to the Chinese trade policy and the regional commitment for the ASEAN+3+2+1 cooperation. Fourth, APEC members have has improved their ability to absorb external shocks as indicated by the shortened half-life reported overtime, especially when the post-crisis era is included.PPP, RIP, Non-linear Endogenous Breaks, Panel Unit Root Tests, Economic Integration

International Parities and Business Cycle Synchronization in the Asia Pacific Region

The 1997 financial turmoil, in conjunction with the escalating global uncertainties and exchange rate volatilities, has revealed the need of APEs (especially East Asian) to formulate new development path towards sustainable growth. Yet, no ideal solution has been proposed and major concerns are now centered at finding an equilibrium position within macroeconomic trilemma: the incompatibility between capital mobility, monetary policy independence and a fixed (stable) exchange rate regime. The present thesis tries to tackle the issue from two standpoints. First, the extent of economic integration: (i) goods (and services) versus financial market integration; (ii) regional (within ASEAN+3+2+1) versus global (US, Japan, China) integration, and (iii) over time, for the pre- and post-liberalization period as well as the pre- and post-crisis period. Second, the choice of optimal exchange rate regime underneath the tendency towards regional integration. Two major analyses are being conducted. The first engaged with the international parities that include the PPP, UIP and RIP conditions (1976M1-2007M1). The latter then deals with the feasibility of OCA, which focus on the Business Cycle Synchronization assessment (1960-2004) among the selected APEs vis-à-vis the US, Japan and China. To accomplish the analyses on international parities, both univariate and panel-based unit toot tests are adopted. Endogenous breaks and the half-life estimation are conducted to capture the shocks adjustments towards the equilibrium, overtime. As for the OCA analyses, the band-pass filtering is used to construct business cycles. The ARDL modeling and UECM are further utilized to assess the long-and short-run co-movement of aggregate economic behavior as justification of common cycles and shocks synchronization. Several important findings are worth noting. First, the support for PPP is time-specific and time-dependent. Supports for PPP and goods markets integration were found when the data was extended to include the post-crisis period. PPP failure prior to 1997 is confirmed by the exchange rate misalignment of APEs. The evident that regional currencies were overvalued prior to the 1997 speculative attacks was more apparent for Taiwan, South Korea, Singapore, Thailand and the Philippines. However, regional authorities have shown some form of PPP-oriented rule as a basis for their exchange rate policy in the aftermath of Asian crisis, in order to maintain international competitiveness and to stabilize domestic income. In addition, supports for UIP are neither concrete, most probably due to the existence of time-varying risk premium as well as possible effects of central bank interventions especially among the developing East Asian. Hence, the commencement of monetary expansion to defend currency remains as policy debate. Then, RIP holds for all of APEs regardless of numeraire used, except South Korea-China. The finding coincides with the increased regional financial integration prompted by financial liberalization, technological breakthroughs, and growth in the capitalization among APEs. However, the variety of endogenous breaks occurred throughout the 1980s and 1990s suggests that financial markets are more vulnerable than the foreign exchange and goods markets. Empirically, APEs financial markets are still dominated by the US market though there is an increased of Japanese and Chinese influence in the post-liberalization era. Lastly, the co-movements of ASEAN-US-Japan-China cycles are confirmed but more evident when the post-crisis period is included. Nevertheless, both the long- and short-run modeling indicates that the idiosyncratic and common shocks of ASEAN economies are more identical to the Japanese experience rather than the US whereas the Chinese influences are on the rise. Hence, the formation of OCA will be more beneficial and less risky if Japan is included. In brief, the findings imply an improved integration process among the APEs. Empirical evidences, when putting together, have shown partial fulfilment of the three (out of five) fundamental criterions for OCA. Yet, macroeconomic disparities are still persisting especially among the emerging-developed markets. And, there is no evidence to support recent proposal of decoupling from the global markets. In other words, sub-group financial deepening, currency arrangements and early warning system construction are more feasible and open regionalism should be promoted. Moreover, the sequencing problem of trade and financial liberalization should be corrected in the process of building sustainable development

Malaysia and China: The Trade Balances, Foreign Exchanges and Crises Impacts

China appears as the biggest trading partner for ASEAN economies, but it is inconclusive whether the complementarities between China and regional economies offset China’s competitive threat. This study tries to assess if real exchange fluctuations and the demand-supply channels determine the Malaysia-China trade balances in the global crises era, 1997–2010. The finding generally supports the complementary role of China in the Malaysia-China bilateral trading. However, despite the long-run effect of real exchange on trade balances, the Keynesian demand channel was not uphold during and after the global financial crisis—due to the contractionary effect on Malaysian output. The Chinese inflation impact is also not evident following the foreign exchange shocks. Meanwhile, currency devaluation for exports gains is insufficient to sustain Malaysia output expansion against China. Further productivity growth in real and tradable sectors is essentially needed

International Capital Mobility and Financial Integration: The Asia Pacific Perspective

This study is conducted to examine the extent of capital mobility and financial integration in the Asia Pacific region. First, the Feldstein-Horioka approach is adopted to determine the capital mobility among the US, Japan and eight Asia Pacific countries. Second, the Real Interest Parity is employed to examine the financial integration amongst these countries. To capture the effect of financial liberalisation on these countries, the sample period is divided into two sub-periods, the pre-(1971:Q 1- 1983:Q4) and the post-liberalisation era (1984:Ql-2000:Q3). All empirical evidences are demonstrated through the application of cointegration tests, Granger-causality, Variance Decompositions (VDCs) and Impulse Response Functions (IRFs). The indications of non-co integrated and inactive of causality chains of saving investment relationships have provided sufficient evidence for the high capital mobility for all studied countries (including the United States and Japan) in both long run and short run. These findings are thus not supporting the argument which claimed that the saving-investment relationship is only applicable for small open countries. Hence, the failure of most previous researchers to establish such results may therefore reflect the method used rather than any inherent deficiency in the saving-investment relationship. Moreover, improper treatment of non-stationarity variables may yield results that are less favourable to long run relationship between the two aggregates. Results of real interest parity have indicated the dynamic causal linkages and greater financial integration amongst Asia Pacific countries during the post-liberalisation era. Relative active Granger-causal chains and the VDCs results have also demonstrated that ASEAN-5 are more interdependent among themselves as compared to the whole region. In addition, Singapore is found statistically endogenous in the multivariate system during post liberalisation, for both ASEAN-5 and the Asia Pacific-l0 model. This would imply that Singapore has been a vulnerable (to the world market) but very competitive and efficient financial centre since 198 0s. Moreover, the results of VDCs and IRFs have confirmed that the movements of real interest rates in Asia Pacific countries are mainly driven by both the US and Japan. However, the US market has much more dominance power than Japan, implying that Japan has not overtaken the role of US in the Asia Pacific regional financial market. Increased capital mobility and high regional financial integration have always entailed with large capital inflows into the developing Asia Pacific countries. Despite the potential welfare gained, capital inflows are most likely associated with monetary and price instability, contagion effects and speculative investments. Hence, the capital coping strategies and capital market restructuring will be the key interest for regional policy makers. Also, to provide a collective defense mechanism against systemic failure and monetary instability, this study proposes the Asia Pacific Optimal Currency Area

On Volatility Spillovers and Dominant Effects in East Asian: Before and After the 911

The present paper examines the dynamic effects of volatility spillovers and dominant role (the second-moment) of the US, Japan and Hong Kong in the East Asian equity markets. To evaluate the recent September 11 (911) impact, two sub periods – before and after the tragedy, are being considered based on daily market returns. The upshots of our findings are five-fold. First, for all markets the constant risk components, as well as the ARCH and GARCH effects are significantly detected, implying the persistency of volatility in East Asian equity markets. Nevertheless, not all indexes show asymmetrical news effects. Though all indexes show leverage effects, they are significant only for certain countries including the US and Japan, which is consistent with empirical literature. Second, the volatilities of these equity markets are bounded in common stochastic trends, at least in the long run. Third, the Hong Kong long run coefficients are more significant than that of US or Japan before the 911 calamity. Nonetheless, there is sufficient evidence showing that the US spillovers were transmitted via Hong Kong. After the 911, the Hong Kong’s spillovers trim down while Japanese influence enhance as in Malaysia, Philippines, Thailand and Singapore. Taken as a whole (1998-2002), Japanese spillovers are relatively small and nonsignificant in some East Asian equity markets. Fourth, the ECT coefficients are significant but small (except for Hong Kong). The East Asian equity markets are thereby endogenously determined and the volatility adjustments to the long run equilibrium are slow, once being shocked. The ECT coefficients slightly improved after 911. Fifth, volatilities in the East Asian equity markets are attributed mainly to the shocks of local and regional factors rather than the world factor. In a nutshell, the volatility spillovers and the Hong Kong- and US-dominant effects have been confirmed. Hitherto, the 911 impact is relatively small and somewhat inconclusive.East Asian; Spillover Effect; Dominant Effect; EGARCH-M; ARDL Bounds Testing Approach

China-Malaysia’s Trading and Exchange Rate: Complementary or Conflicting Features?

Over the last decade, China and Malaysia have committed to export-led growth policy based on maintenance of their undervalued currencies. While both nations have recorded current account surplus and devoted for regional trade integration, it was lately claimed that the Chinese foreign exchange regime poses her as a formidable export competitor and offers further threat to the crowding out of other developing Asian, including Malaysia. Such scenario motivated us to examine the dynamic nexus of exchange rate impact on bilateral export and import flows between China and Malaysia. Our analysis contributed in using high frequency monthly data for the recent period from January 1990 to January 2008, based on the Autoregressive Distributed Lag (ARDL) bound testing procedure and generalised impulse response analysis. Our empirical findings reveal that the Marshall-Lerner condition holds in the long run but only the short run import demands adhere to the potential J-curve pattern. In brief, the study supports for the complementary role of China instead of conflicting (competing) features in the China-Malaysia bilateral trading.Exchange rates, J-curve, Marshall-Lerner Condition, ARDL Bound Test

Measuring Capital Mobility in the Asia Pacific Rim

This study revisits the Feldstein-Horioka puzzle by investigating the saving-investment nexus through the unit root test, cointegration procedure, unrestricted VAR causality, and dynamic OLS (DOLS). Ten Asia Pacific nations of different level of economic development and financial openness were being examined, using data from 1971-1999. Overall, the long run capital mobility is more apparent for four newly industrialised economies while capital flows in ASEAN countries seem to be more restricted (especially Indonesia and Thailand). As for the US and Japan, their long run saving retention coefficients are in the moderate range (0.56 and 0.45). In brief, our findings indicate that the heftiness of Feldstein-Horioka criterion in measuring capital mobility is more subjected to econometric specifications rather than country size alone.Feldstein-Horioka puzzle; capital mobility; Asia pacific region; unrestricted VAR causality; dynamic OLS

China-Malaysia’s long run trading and exchange rate: complementary or conflicting?

This paper examines the long run dynamics of exchange rate and bilateral export-import flows between China and Malaysia. Our analysis contributed in using high frequency monthly data for the recent period from January 1990 to January 2008, based on the Autoregressive Distributed Lag bound testing procedure, the fully modified OLS, dynamic OLS and rolling estimations, as well as the generalised impulse response (IRF) and variance decomposition (VDC) analyses. Our empirical findings reveal that the Marshall-Lerner condition holds in the long run but the export-import demands do not adhere to the J-curve pattern. And, expansionary effect is of greater evidence for Malaysia due to real exchange shocks but inconclusive for China. More important, the VDC results imply that China-Malaysia trade is along the sustainable path. In brief, the study supports for the complementary role of China instead of conflicting (competing) features in the China-Malaysia bilateral tradingExchange rates, J-curve, Marshall-Lerner Condition, ARDL Bound Test, Rolling, FMOLS, DOLS

The Impact of Yuan/Ringgit on Bilateral Trade Balance of China and Malaysia

The exposure to exchange rates remains an unresolved issue in international trade literature. The issue is particularly relevant to China and Malaysia, whom relaxed their USD pegging the same day in the mid of 2005. Our paper investigates the exchange rate exposure of China-Malaysian bilateral trade balance over the last 20 years using a standard trade balance equation which is a function of local income, foreign income, and the bilateral real exchange rates of yuan/ringgit. Our modeling is somewhat different with the literature where we take into account the structural breaks of the 1997 Asian currency crisis as well as the fixed-exchange rate regime adopted by the Malaysia. With high frequency monthly sample (Jan1990-Jan2008), we documented GARCH effect in the trade model. Taking that into consideration, our result shows that real exchange rates do play a role in the bilateral trade of China-Malaysia. The long run exchange rate elasticity is consistent with the Marshall-Lerner condition. However, the short run J-curve phenomenon is somewhat inconclusive.Exports, Imports, exchange rates exposure, J-curve, structural breaks, GARCH