Bakri Abdul Karim*, Mohamad Jais and Abu Hassan Md. Isa
Faculty of Economics and Business, Universiti Malaysia Sarawak (UNIMAS), 94300 Kota Samarahan, Sarawak, Malaysia.
ABSTRACT
This paper examines the response asymmetries of the Indonesian market to two developed markets – the US and Japan. We employed weekly data from January 1988 to December 2007 and simple regression and VAR analyses. In line with previous studies, we found evidence for the presence of response asymmetries in the Indonesian market. The evidence strongly suggests significant responses of the Indonesian market to the US and Japanese markets downturns. Thus, the benefits of international portfolio diversification tend to diminish when they are needed most, that is, during market downturns. To the certain extent the Japanese market is more important than the US in influencing Indonesian market. Therefore, from the equity market perspective, the formation of yen bloc may be forthcoming.
Keywords: Response Asymmetries, Portfolio Diversification, Generalize Impulse Response Function.
INTRODUCTION
The widening of economic interdependence in Asia has been paralleled by a deepening of interdependence through rising intra-regional trade and investment. Until the mid-1980s, trade in Asia was dominated by exports across the Pacific. With Asia growing much faster than the US and trade friction between the two sides of the Pacific escalating, intra-regional trade among Asian countries has increased sharply, while the relative importance of the US as an export market for these countries has declined (Kwan, 2001). Intra-regional trade expansion is one of the efficient ways of integrating to the much larger international economy as the countries become more competitive (Chowdhury, 2005).
In addition, Kearney and Lucey, (2004) noted that the world’s economic and financial systems are becoming increasingly integrated due to the rapid expansion of international trade in commodities, services and financial assets. Earlier empirical studies on market integration generally suggest lower correlations among national stock markets (Grubel, 1968; Levy and Sarnat, 1970; and Solnik, 1974), implying the existence of potential benefits of international portfolio diversification. Nowadays, however, the world capital markets have been increasingly integrated and co-movements among the leading world financial markets have been rising (Blackman et al., 1994;Masih and Masih, 1997; and Ghosh et al., 1999). Moreover, the co-movements among stock prices are manifested strongly during periods of major financial disturbances such as the October 1987 market crash and the 1997 Asian financial crisis.
For the emerging economies, especially Indonesia, there have been very few empirical analyses done in this area in the last few decades. Roll (1995) affirmed that although Indonesia has had an active equity market for a number of years, no empirical studies on this market have appeared in Western scholarly journals. However, in recent years, the vast growing economics activities and the increasing investment opportunities in some emerging markets have attracted investors’ and researchers’ attention. Recently, another interesting aspect of studies has been added in the analysis of international interactions among stock prices. Essentially, this so-called “response asymmetry” by Pagan and Soydemir (2001). The responses of an equity market to upturns and downturns in other equity markets may not be symmetrical. This means that returns in one stock market react differently to market upturns than downturns in terms of both speed and magnitude.
Pagan and Soydemir (2001) noted that response asymmetry suggests stronger reaction to market downturns than market upturns. The presence of asymmetric responses might be due to “optimism or pessimism” of investors who, being risk averse, are more concerned about losing their investments during periods of negative returns than gaining during periods of positive returns. Erb et al. (1994) and Bahgn and Shin (2003) noted that the difference in market reaction to positive and negative changes in other markets may be due to investors’ different expectations about the impact of international market changes. Thus, the asymmetric responses seem to be consistent with the observed strong co-movements among stock prices which are apparent during the large market downturns or during periods of major disturbances (Ibrahim, 2006).
The purpose of this paper is to extend the line of research to the case of Indonesian stock market by assessing whether this market responds asymmetrically to the two world’s dominant markets – the US and Japan. This paper contributes to the literature in several ways. First, unlike previous studies that use daily data (Pagan and Soyedmir, 2001; Bahng and Shin, 2003) and monthly data (Ibrahim, 2006), this study uses weekly data. The daily data contain too much noise and are subject to the problem of non-synchronous infrequent trading (Ibrahim, 2005). Thus, this might lead to erroneous conclusion in the lead-lags relationship among the variables. In addition, the transmission of shocks may take place within few days and, thus, cannot be fully captured by using monthly data. However, the problem could be reduced if a weekly interval of the indices is used (Hung and Cheung, 1995).
Second, various studies on the Indonesian market have focused on causal linkages nexus between Indonesia to developed markets to assess benefits of international diversification in this market, for instance Arshanapalli et al. (1995); Ibrahim (2005); and Majid et al. (2008). We explore the possibility of asymmetric responses in the Indonesian stock market. Thus, we hope to shed further light on the issue. If the Indonesian market response more strongly to market downturns, then the arguments’ for potential benefits of international portfolio diversification may be greatly weakened since it is during the times of market downturns that these benefits are mostly needed (Ibrahim 2006).
Third, while previous studies use impulse response functions (IRF), we employ generalized impulse response analysis as developed by Pesaran and Shin (1998), which is invariant to the ordering of the variables in the VAR model. This feature of the generalized impulse responses is particularly useful for studies on equity markets, which are generally characterized by quick price transmissions and adjustments (Ewing et al. 2003).
Thus in this paper, we assess the Indonesian market responses to upturns and downturns in the markets of US and Japan. We attempt to partially fill this gap in the literature and to provide recent empirical evidence on market integration in the Indonesian market, relying on longer and more recent sample of data and asymmetric responses analysis.
The rest of this paper is structured as follows. Section 2 presents literature review while Section 3 provides the empirical framework and description of the data. The fourth section provides the empirical results and discussion. Finally, the fifth section concludes the study, providing some implications and proposing some recommendations for further study.
*Correspondence Address: Bakri Abdul Karim, Faculty of Economics and Business, UNIMAS, 94300 Kota Samarahan, Sarawak. Tel: +6 082 582423 Fax: +6 082 671794 E-mail: akbakri@feb.unimas.my
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