Unlike for developed markets, there is no consensus in the current literature on the extent of market linkages inemerging markets. Some studies indicate that, although they are improving, emerging markets are much more fragmented than developed markets. Eichengreen and Park (2004) and Jeon et al. (2006) find that, in contrast to the developed markets of Americas and Europe, the markets in the Asia-Pacific are fragmented, due to a greater prevalence of emerging countries in that region with underdeveloped equity and bond markets. The lack of strong trade and monetary unions in the emerging markets is another reason for higher market segmentation, compared to that of developed markets. Christoffersen et al. (2012), who use a dynamic copula model to test long-run and short-run linkages in the emerging markets, find higher correlations in developed markets than in emerging markets, which report lower tail dependence. Phuan et al. (2009) use the Johansen and Juselius multivariate cointegration procedures, the Granger-causality tests and a variance decomposition analysis to find an increase in market linkages in the Association of Southeast Asian (ASEAN) countries. Corhay et al. (1995), who estimate market ties in the Pacific Basin markets using a multivariate cointegration process, conclude that the markets are integrated and exhibit strong regional aspects – Asian versus Pacific. Examples of other studies which find linkages in emerging markets include those of Piesse and Hearn (2002) in South Africa; Azman-Saini et al. (2002) and Yang et al. (2003) in Asia; and Phylaktis and Ravazzolo (2002) in the Pacific-Basin markets.
Few studies also estimate time-variant linkages in the emerging markets. An earlier study by Hung and Cheung (1995) uses Johansen’s multivariate cointegration approach to validate the existence, as early as the period 1987-1991, of market interdependence amongst the emerging Asian markets, although they fail to identify any linkages during the preceding period. An increase in the
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development of financial markets, coupled with rising economic growth, has contributed to the increase in linkages in the emerging markets. Kim and Lee (2012) find an increase in financial integration amongst East Asian markets after the Asian crisis of 1997-1998. Similarly, Auster and Foo (2015) state that the growth and integration of financial services have led to a sharp increase in financial integration in the ASEAN market. Pretorius (2002), who examines ten emerging stock markets for the period 1995-2000, identifies bilateral trade and the industrial production growth differential as significant determinants of correlations on a cross-sectional basis.
Some studies find either weak or no linkages in the emerging stock markets. De Fusco et al.
(1996) use the Johansen and the Johansen and Juselius cointegrations to analyze the US and several emerging markets but fail to discover any linkages between the markets. Using a multivariate asymmetric GARCH approach, Joshi (2011) finds the magnitude of volatility linkages to be lower in the Asian stock markets, indicating linkages. Similarly, Click and Plummer (2005) find weak cointegration in emerging markets. In particular, a higher level of segmentation in the Asia-Pacific markets means greater opportunities for portfolio diversification (Bekaert and Harvey, 1995; Allen and Macdonald, 1995; Chambet and Gibson, 2008; Jayasuriya et al., 2009).
A few studies provide reasons for the lower levels of linkages amongst the emerging markets, compared to the developed markets. A study by the Danareksa Research Institute (2004) concludes that the process of financial integration in Asia lags behind that of Europe, due to the underdeveloped bond markets. The study further finds that volatility is less pronounced in some of the emerging markets, which means that these markets are not as likely as the developed world to react to adverse shocks. Similarly, Agyei-Ampomah (2008) concludes that the African stock markets remain isolated from the global markets, offering strong diversification benefits. Auster and Foo (2015) blame the
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negative implication of contagion during the 1997-1998 Asian financial crisis as a reason for the slowdown in the financial integration between the region and the rest of the world after the end of the crisis; however, the trend seems to have reversed in recent years.
The underdevelopment of emerging markets can be investigated by using a measure such as market liquidity, with the developed markets likely to exhibit higher liquidity. However, research in this area remains scarce, with a few studies such as that by Lucey and Zhang (2009), who limit their analysis to the emerging markets. The study in Chapter 5 addresses this gap in the literature by testing the significance of the determinants of market linkages between the less liquid (thin) markets and the liquid (active) markets, using a sample set of markets from both the emerging and the developed countries.
Another common theme in the available literature is the increase in the linkages between emerging and developed markets. Dimitriou et al. (2013) use the fractionally integrated asymmetric power autoregressive conditional heteroscedasticity (FIAPARCH) framework to find significant increases in correlations between BRICS (Brazil, Russia, India, China and South Africa) and the US from early 2009, implying increased linkages during bullish rather than bearish markets. Another study, by Zhang et al. (2013), uses a DCC model to find higher market linkages between the BRICS and the developed equity markets after the 2008 financial crisis. Lahrech and Sylwester (2011) state that the correlations between Latin American (Argentina, Brazil, Chile, and Mexico) and US equity returns expanded between 1988 and 2004. Auster and Foo’s (2015) findings support increasing integration between Australia and the Asian-Pacific economies. An empirical study by Chambet and Gibson (2008) uses GARCH (1,1) in the mean excess stock returns model and finds that the emerging market remains segmented, and that the process of financial integration declined during the market
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crisis of the 1990s. They conclude that the emerging markets are less correlated with the developed markets, and therefore offer opportunities for international portfolio diversification.
Despite the lack of consensus on the state of linkages in the emerging markets, an underlying theme in the literature is that deregulation in emerging markets has removed several restrictions on the pricing mechanisms of financial assets, one of the pre-requisites for market integration (Bekaert and Harvey 2003). Consequently, capital is becoming increasingly more mobile across national boundaries, as developed nations rely more extensively on the savings of emerging markets to supplement their domestic economies. Improvements in technology and developments in electronic payment and communications have substantially improved the cross-border mobility of capital and investments by reducing arbitrage opportunities across financial centers. Cross-listing of securities in global equity markets has also contributed to the linkages (Mobarek, 2001). Furthermore, global institutions such as the IMF and World Bank continue to encourage harmonization of regulations and keeping up with the international best practice of fewer trade tariffs, thereby further increasing the impetus for linkages between the financial markets (Rossi, 1999).
One shortcoming of several studies on financial integration in emerging markets is their relatively short analysis period. For example, Yeoh et al. (2010), using the time-varying Kalman Filter technique to estimate the stock market integration between Malaysia and the world markets, report an increase in the levels of integration during the period of global crisis. However, their model, which uses data from 1988 to 2009, does not include the period after the 2008 recession. It is important to identify contagion when examining the linkages in the post-2008 recession period to determine if they are affected by the market crisis. Similarly, Phuan et al. (2009) try to estimate cointegration using a sample size of only 11 years, which is not a sufficient period to measure such
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long-run equilibrium type relationships. My research addresses this literature gap by using a longer time series of 18 years, encompassing 25 global financial markets.