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

Abstract

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