Long-run equilibrium, short-term adjustment, and spillover effects across Chinese segmented stock markets and the Hong Kong stock market

Transcription

1 Hong Kong Bapis Universiy HKBU Insiuional Reposiory Deparmen of Economics Journal Aricles Deparmen of Economics 2008 Long-run equilibrium, shor-erm adjusmen, and spillover effecs across Chinese segmened sock markes and he Hong Kong sock marke Zhuo Qiao Thomas C Chiang Wing Keung Wong Hong Kong Bapis Universiy, awong@hkbu.edu.hk This documen is he auhors' final version of he published aricle. Link o published aricle: hp://dx.doi.org/0.06/j.infin Recommended Ciaion Qiao, Zhuo, Thomas C Chiang, and Wing Keung Wong. "Long-run equilibrium, shor-erm adjusmen, and spillover effecs across Chinese segmened sock markes and he Hong Kong sock marke." Journal of Inernaional Financial Markes Insiuions and Money 8.5 (2008): This Journal Aricle is brough o you for free and open access by he Deparmen of Economics a HKBU Insiuional Reposiory. I has been acceped for inclusion in Deparmen of Economics Journal Aricles by an auhoried adminisraor of HKBU Insiuional Reposiory. For more informaion, please conac reposiory@hkbu.edu.hk.

2 Long-run equilibrium, shor-erm adjusmen, and spillover effecs across Chinese segmened sock markes and he Hong Kong sock marke Zhuo Qiao a, Thomas C. Chiang b, Wing-Keung Wong a,c a Deparmen of Economics, Naional Universiy of Singapore, Singapore b Deparmen of Finance, Le Bow College of Business, Drexel Universiy, USA c Deparmen of Economics, Hong Kong Bapis Universiy, Hong Kong Absrac This paper adops a novel FIVECM-BEKK GARCH approach o examine he bilaeral relaionships among he A-share and B-share sock markes in China and he Hong Kong sock marke. The evidence shows ha hese sock markes are fracionally coinegraed. Analyses of he spillover effecs across hese markes indicae ha he A-share markes are mos influenial. The relaxaion of governmen resricions on he purchase of B shares by domesic residens acceleraes he marke inegraion process of A-share markes wih he B-share and Hong Kong markes. The effecs of he Asian crisis on he sock-reurn dynamic correlaions vary across hese markes. JEL classificaion: G0; C32; F36 Keywords: Sock marke segmenaion; Coinegraion; FIVECM; Mulivariae GARCH

3 Long-run equilibrium, shor-erm adjusmen, and spillover effecs across Chinese segmened sock markes and he Hong Kong sock marke. Inroducion As a mechanism for developing he Chinese sock marke, he Chinese governmen has adoped a marke segmenaion policy ha divides is sock marke ino a domesic board and a foreign board o caer o he needs of differen invesors. Companies can issue A shares, which only Chinese ciiens living in mainland China can buy; hey are also allowed o issue B shares, which can be bough by foreign invesors, including Chinese invesors residing in Hong Kong (HK), Macau, or Taiwan. A and B shares are lised on he Shanghai (SH) Sock Exchange (SHSE) and he Shenhen (SZ) Sock Exchange (SZSE), namely, SHA, SHB, SZA, and SZB in mainland China. A shares are denominaed in he local currency (RMB), while B shares are denominaed in U.S. dollars on he SHSE and in HK dollars on he SZSE. Because of he isolaion of Chinese currency from foreign currencies, differen informaion environmens, diverse regulaory policies, and heerogeneous invesors, he segmened markes have shown various paerns of evoluion. Hong Kong is an imporan parner of mainland China for her locaion, economic developmen, and poliical relaionship. From boh geographical and sraegic poins of view, Hong Kong acs as an inermediary for China's inernaional rade hrough This resricion was relaxed on February 22, 200, when i became permissible for domesic ciiens o buy and sell B shares.

4 re-expors and offshore ransacions. In addiion, a subsanial amoun of capial o finance China's economic expansion has been raised hrough Hong Kong s channels. However, his inermediary role for managing and engaging inernaional rade and capial also shapes Hong Kong s economic srucure, leading o her economic prosperiy. These mulilaeral economic aciviies help in bridging know-how gap, ransferring echnology, disseminaing and processing informaion, creaing invesmen opporuniies, and generaing higher reurn, bu hey also assume higher risk for sock markes in boh Hong Kong and mainland China. I is his unique seing as well as he increasingly imporan role played in world financial markes ha promps us o explore he explici long-run equilibrium, shor-run adjusmen, and spillover effecs across he mainland China sock markes on wo sock exchanges (SHSE and SZSE) and he HK sock marke. In his sudy, we incorporae a fracionally inegraed vecor error correcion model (FIVECM) ino he BEKK GARCH framework (Engle and Kroner, 995) o examine he bilaeral relaionships beween each of he following six pairs of sock markes: HK-SHA, SHB-SHA, and SHB-HK; HK-SZA, SZB-SZA, and SZB-HK. This finding will be very useful o invesors, since he presence of he fracional coinegraion implies he exisence of boh long-run co-memories and long-periodic comovemens beween he wo markes. As a resul, i would affec invesors asse allocaion sraegies in he long and medium erms (Cheung and Lai, 995). A he same ime, he presence of a fracional coinegraing relaionship beween wo sock markes has an imporan implicaion for heir shor-run linkages. As a generaliaion 2

5 of he sandard linear VECM, which allows only he firs-order lag of he coinegraion residual o affec he equilibrium relaionship, he FIVECM specificaion is appealing, since i no only helps invesors o observe shor-run adjusmens and long-erm equilibrium relaionships among co-inegraed variables, bu also accouns for he possible long memory in he coinegraion residual series ha oherwise migh disor he esimaion (Ding e al., 993). Finally, incorporaing he FIVECM ino a bivariae BEKK formulaion allows us o capure he second momen auocorrelaions of he reurn series and analye he firs and second momen spillover effecs across hese sock markes simulaneously. Our empirical resuls show ha all six pairs of sock markes are fracionally coinegraed. In each of he six pairs, only one marke adjuss o reurn o equilibrium. We also find bi-direcional volailiy spillover effecs beween he A-share markes and he B-share markes and beween he B-share markes and he Hong Kong marke. However, we find only unidirecional volailiy spillover effecs from he A-share sock markes o he Hong Kong sock marke. The evidence concludes ha he A shares are he mos influenial markes in boh mean and volailiy spillover effecs. Invesigaion of he dynamic pah of correlaion coefficiens suggess ha relaxaion of governmen resricions on he purchase of B shares by domesic residens increased he correlaion beween he A- and B-share markes and acceleraed he marke inegraion process of he A-share markes wih he Hong Kong sock marke. Our resuls also sugges ha he Asian crisis had a differen spillover effec on sock-reurn dynamic correlaions across Chinese segmened markes and he Hong 3

6 Kong sock marke. The remainder of his paper is organied as follows. Secion 2 offers a review of he relevan lieraure. Secion 3 discusses he daa and mehodology. Secion 4 provides empirical resuls, and Secion 5 summaries our conclusions and commens. 2. Lieraure review Much empirical work has been done on analying he Chinese segmened sock markes and he linkages beween Chinese segmened sock markes and inernaional sock markes. For insance, Li e al. (2006) find ha he risk premiums associaed wih he Hong Kong and mainland Chinese markes in a wo-facor model successfully explain he cross secion of reurns on he A and H shares. They conclude ha he risk premiums associaed wih he segmened A-share and H-share markes exer crucial impacs on he price differenials beween he wo classes of shares. Chakravary e al. (998) repor he bivariae reurn correlaions among he A- and B-share indices, as well as Hong Kong, Japanese, and U.S. marke indices and sugges ha he Chinese marke is sill isolaed, even afer he inroducion of B shares. Wang and Firh (2004) find a unidirecional reurns spillover effec from developed sock markes o sock indices in he Greaer China economic one. Several groups have applied Granger causaliy ess o deermine he lead-lag relaionships beween he A-share and B-share markes. For example, Kim and Shin (2000) find ha he A-share markes lead he B-share markes before 996, bu he relaionship eiher disappears or reverses afer 996. On he oher hand, Laurence e al. 4

7 (997) observe a causal relaionship from he SHB o all oher Chinese markes and feedback from SHA and SZB o SHB. In addiion, adoping VAR and bivariae GARCH-M models, Yeh e al. (2002) find ha he unexpeced changes in he premium raio of A-share price over B-share price conribue o he reurn volailiy of boh A and B shares. Chiang e al. (2007) presen evidence ha he correlaion coefficiens beween A-share and B-share sock reurns are ime varying. Their resuls sugges ha he ime-varying correlaions are significanly associaed wih excessive rading aciviy measured by excessive rading volumes and high-low price differenials. Our work exends he exising lieraure in he following wo ways. Firs, our paper is he firs o examine he equilibrium mechanism among segmened Chinese sock markes and he Hong Kong sock marke. The FIVECM approach is a more general specificaion because i conains boh he radiional VECM and he effecs of he long memory of he coinegraing relaionship, which is imporan for revealing he rue relaionships among markes. Second, by combining he FIVECM wih a bivariae BEKK-GARCH formulaion, his model allows us o invesigae Chinese sock-reurn linkages in a mulivariae framework. Differen from previous sudies ha mainly use univariae models, he bivariae BEKK-GARCH mehod enables us o deec he condiional correlaions beween hese markes. Wihin his novel framework, empirical lead-lag relaionships in he mean as well as volailiy in a cross-marke seing can be simulaneously esimaed. The empirical resuls derived from his research reveal he naure of he complicaed srucure beween wo differen 5

8 markes, which, in urn, provides addiional informaion o invesors and fund managers for heir invesmen decisions and sraegies in hese markes. Our findings are also useful for policy makers in seing regulaions for hese markes. 3. Daa and mehodology 3.. Daa The daa in his sudy include price indices of Shanghai A-share (SHA), Shenhen A-share (SZA), Shanghai B-share (SHB), Shenhen B-share (SZB), and Hong Kong Hang Seng (HK). All daa are aken from DaaSream Inernaional, covering January 995 hrough December In ligh of he evidence of he unusual paern of he day-of-he-week effec observed by Cai e al. (2006), in his paper we employ weekly Wednesday indices o alleviae he impac of noise creaed by using daily daa and o avoid day-of-he-week effecs Mehodology One of he principal asks in his paper is o examine sock-reurn behavior by exploring he shor-run dynamics in relaion o he long-run equilibrium in a cross-marke seing. To achieve his end, we employ he coinegraion es o examine wheher wo series ha drifed apar in long-run equilibrium have a endency o be brough back ogeher again. Usually, he disequilibrium error used in he VECM framework is neiher I() nor I(0) bu follows a fracionally inegraed process, I(d), where -0.5<d <0.5 (Engle and Granger, 987). Wihou accouning for he long memory (when d<0.5) feaure of he disequilibrium error, he rue relaionships 2 Cai e al. (2006) find ha average Monday reurns from A-share indices are significanly negaive during he hird and fourh weeks bu average Tuesday reurns on mos of he A-share and B-share indices are negaive during he second week of he monh. 6

9 among coinegraed variables disclosed by radiional VECM may be misspecified. To circumven his problem, we employ a fracionally inegraed VECM (Baillie, 996) o sudy he naure of comovemens for each pair of sock-reurn series. Firs, we employ he Engle-Granger (987) wo-sep approach by fiing he following dynamic ordinary leas squared model (DOLS) (Saikkonen, 99) o he pairs of sock indices and hereafer obain he esimaed coinegraing residual ẑ : y p y2 j j p y 2 j v ˆ ˆ. () y y2 where y and y 2 are a pair of sock indices in naural logarihms; each could represen SHA, SHB, SZA, SZB, and HK. By using his procedure, we can remove he deleerious effec of shor-run dynamics in he equilibrium error v and obain he esimae ˆ, which is super-consisen as well as efficien (Sock and Wason, 993). Nex, o es for he exisence of any long memory in he ẑ series, we use Lo's modified R/S es (Lo, 99). If we confirm ha ẑ follows an I(d) (-0.5<d<0.5) process, hen y and y 2 are said o be fracionally coinegraed. In his siuaion, we proceed o fi he following auoregressive fracionally inegraed moving average (ARFIMA) model: 3 d L ( ) ( L)( L) ˆ a (2) where (L) and (L) are MA and AR polynomials, L is a backward shif operaor, 3 For 0 < d < 0.5, he ARFIMA process is said o possess a long memory or long-range dependence. When d = 0, an ARFIMA process can be reduced o he convenional ARMA process. For 0.5 < d < 0, i has a shor memory. For 0.5 < d <, he process is mean-revering because here exiss a non-long-run effec of an innovaion on he fuure values of he process. For d >, he process is no mean-revering, since any shock o he process could make i drif away from is equilibrium permanenly. See Baillie (996) for more informaion. 7

10 and a is an i.i.d. noise. If here is any coinegraion relaionship among he variables, a VECM represenaion can be esablished o adequaely capure he relevan long-run and shor-erm relaionships (Engle and Granger, 987). We incorporae he VECM ino he following bivariae FIVECM o accoun for he fracional inegraion propery in ẑ series by employing he ARFIMA model (2): m m i i i 2 2i i i y c a y y m m i i i 22 2i 2 i i y c a y y. (3) Boh y and y2 in equaion (3) represen he reurn series for each pair of sock indices, namely, HK-SHA, SHB-SHA, SHB-HK, HK-SZA, SZB-SZA, and SZB-HK in his sudy; is he vecor of error erms; and he coefficiens and ' (, 2 ) 2 indicae he shor-run dynamic adjusmens wih heir magniudes represening he speeds of he adjusmen. A VAR (m) srucure in he VECM model, in paricular m=, is employed in his paper. To capure he heeroskedasiciy in he reurn series and o ensure ha he variance marix of error erms is posiive definie, we apply he following bivariae BEKK (, ) model (Engle and Kroner, 995): 4 ~ N(0, ) for =, 2,.. T;, 2, 2, 22, A 0 A ' 0 ' ' A ( ) A B B, (4) ' where is assumed o follow a bivariae normal disribuion condiional on he pas informaion se ; denoes he variance-covariance marix of, which is symmeric and posiive semi-definie; A 0 is a lower riangular marix; and A and 4 BEKK (, ) is usually sufficien o model volailiy in financial ime series. 8

11 B are unresriced square marices. On he basis of his framework, he volailiy spillover effecs across reurn series indicaed by he off-diagonal enries of coefficien marices A and B are esimaed. The BEKK specificaion is a more general and flexible mulivariae GARCH model as here are no resricions imposed on he coefficiens. In his paper, we esimae he FIVECM-BEKK model (i.e., sysems (3) and (4) joinly) in which he coefficien esimaes would be more efficien, and he relaionships among he series would be delineaed more accuraely. 4. Empirical resuls A summary of he basic saisics of he naural logarihm value of price indices is repored in Table. By conducing he ADF and PP uni roo ess o es heir saionariy propery, he resuls indicae ha all of hese series are I (). 5 The nex sep is o esimae he six coinegraion residuals ẑ based on Equaion () for he six pairs of sock indices: HK-SHA, SHB-SHA, and SHB-HK; HK-SZA, SZB-SZA, and SZB-HK. This is done by performing a DOLS esimaion wih lag lengh p=2. The resuling error series are denoed by HK SHA, SHB SHA, SHB HK, HK SZA, and SZB, SZB SZA HK respecively, where he superscrip sands for he dependen variable, and he subscrip for he independen variable. We use Lo's modified R/S es (Lo, 99) o examine he long-memory behavior in he six residual series, and he resuls are conained in Table 2. The evidence indicaes ha all residual series have long memory. This finding leads us o apply 5 The resuls are available on reques. 9

12 he ARFIMA model o model each of hese six series. I may be seen from Table 3 ha all of he esimaed values of d fall ino he range (0, 0.5) and he esimaed coefficiens of he AR erms mee he saionariy condiion, suggesing ha he coinegraing variables follow long-memory saionary processes. We, herefore, conclude ha he six pairs of sock markes are fracionally coinegraed wih each oher. Having verified he feaure of he long-erm coinegraion relaionships in each pair of he sock indices, we proceed o esimae he FIVECM-BEKK(,), and he resuls are presened in Table 4. The esimaed saisics allow us o analye he shor-erm adjusmen, he long-erm equilibrium relaionship, and he spillover effecs beween each segmened Chinese marke and he HK marke. Specifically, he esimaed coefficien ( ) for HK-SHA measures he mean spillover effecs 2 2 from he SHA (HK) marke o he HK (SHA) marke; ARCH(,2) and GARCH(,2) (ARCH (2,) and GARCH(2,)) measure he volailiy spillover effecs from he SHA (HK) marke o he HK (SHA) marke, and parameers and 2 indicae shor-erm adjusmens o he equilibrium of he HK and SHA markes, respecively. 4.. Relaionships among Hong Kong, Shanghai A- and B-share sock markes bu From Panel A of Table 4, 2 has a negaive sign and is saisically significan, 2 is no significan, indicaing ha here is a mean spillover effec from he SHA marke o he HK marke, bu he reverse relaionship does no hold. The value of he shor-erm adjusmen parameer is , which is significan a he % 0

13 level, suggesing ha he HK sock marke makes a parial adjusmen when i drifs away from long-run equilibrium. The magniude of indicaes ha 68.3% of he discrepancy beween he wo sock markes would be correced in each week, corresponding o an adjusmen period of.46 weeks. 2 bears a posiive sign bu is insignifican, suggesing ha he coinegraing relaionship beween he wo markes does no reveal movemens on he par of he SHA sock marke. For he variance equaion, we find ha off-diagonal ARCH (,2) and GARCH (,2) erms are significan, while hose of ARCH (2,) and GARCH(2,) are no, indicaing he exisence of a unidirecional volailiy spillover effec from he SHA o he HK sock marke. Wih respec o he esimaes of he SHB-SHA pair marke, he evidence shows ha 2 is significan bu 2 is no, indicaing a unidirecional mean spillover effec from he SHA o he SHB sock marke. In oher words, SHA leads SHB in reurns. The value of he shor-erm adjusmen parameer is , which is significan a abou he 6% level, suggesing ha he SHB marke adjuss when i drifs away from long-run equilibrium and he adjusmen speed is abou.2 weeks. The non-significance of he 2 esimae indicaes ha he SHA marke is no bound by he coinegraion relaionship. For he variance equaion, he es resuls show ha all off-diagonal ARCH erms and GARCH erms are significan and disclose a bi-direcional volailiy spillover effec beween he SHA and SHB sock markes, implying srong ransmission of informaion beween hese wo sock markes. The hird column of Table 4 provides he esimaes for he SHB-HK pair of sock

14 reurns. From he resuls, we find ha neiher 2 nor 2 is significan, concluding ha here is no spillover effec in he firs momen beween he SHB and he HK markes. The adjusmen speed coefficien is significanly negaive, while coefficien 2 is insignifican, implying ha he HK marke is no bound by he coinegraion relaionship. For he spillover effec of volailiy, evidence shows ha all off-diagonal ARCH erms and GARCH erms are significan, which is similar o he siuaion for he SHA and SHB pair. Thus, we conclude ha here also exiss srong ransmission of informaion beween he SHB and HK sock markes. To sum up, evidence shows ha here are bi-direcional volailiy spillover effecs beween SHB-SHA and beween SHB-HK, bu only a unidirecional volailiy spillover effec from he SHA o he HK marke. We conclude ha he SHA marke plays he mos influenial role among he hree markes: i no only passes reurn realiaions o he SHB and HK markes, bu i also leads in he ransmission of heir volailiies. We also find ha among he hree pairs of sock markes, only one marke is found o adjus o reurn o equilibrium: he HK marke adjuss disequilibrium condiions wih he SHA marke, while he SHB marke adjuss in response o disequilibrium wih boh he SHA and HK markes Relaionships among Hong Kong and Shenhen A- and B-share sock markes Columns 4-6 of Table 4 repor he esimaed resuls of FIVECM-BEKK for HK-SZA, SZB-SZA, and SZB-HK. In general, we find ha he relaionships among hese hree markes are very similar o hose of heir counerpars presened in he sub-secion above. For he HK-SZA pair, we find a unidirecional mean spillover 2

15 from he SZA marke o he HK marke. Nex, he esimaed parameer has a value of , which is saisically significan, suggesing ha he HK marke adjuss as i diverges from is long-run equilibrium wih he SZA. The lengh of he adjusmen is.56 weeks. On he oher hand, he esimae of 2 is no significan, indicaing ha he movemen of he SHA sock marke is no governed by he coinegraing relaionship beween hese wo markes. By checking wih he variance equaions, he resuls indicae ha he volailiy spillover effec is running only unidirecionally from he SZA marke o he HK sock marke. As we inspec he SZB-SZA pair relaionship, our resuls show ha here is no mean spillover effec beween hese wo markes. For he shor-erm adjusmen parameer, we find o be and saisically significan. The comparable coefficien, 2, also shows a negaive sign; however, i is insignifican, suggesing ha he SZB marke makes he adjusmen when i deviaes from a long-run equilibrium relaionship and he speed of adjusmen is abou 2.08 weeks. In conras, no evidence indicaes ha he SZA marke is bound by he coinegraion relaionship. On he basis of he condiional variance equaions, we find ha here are bi-direcional volailiy spillover effecs beween he SZA and SZB sock markes, implying srong ransmission of informaion beween he wo sock markes. Finally, we examine he SZB-HK pair of markes. Since boh 2 and 2 are insignifican, here is no evidence o indicae any spillover effec in sock reurns beween he SZB and HK markes. As far as he adjusmen coefficien is concerned, he esimaed is and saisically significan, while 2 is insignifican, 3

16 revealing ha he disequilibrium beween he wo markes will be correced only by he SZB marke, and he correcion will occur wihin 2.78 weeks. Wih respec o he spillover effec of volailiy, evidence indicaes he exisence of bi-direcional volailiy spillover effecs beween he SZB and HK markes. The model diagnosics repored in Panel B of Table 4 lis Ljung-Box ess of whie noise applied o boh he sandardied residuals and he squared sandardied residual series. I demonsraes ha none of he Ljung-Box es saisics for he HK-SHA, SHB-SHA, SHB-HK, and HK-SZA pairs of markes is significan, indicaing he adequacy of he fied models o successfully capure he dynamics in he firs wo momens of he index reurn series. However, he null hypohesis of he absence of join significance for he SZB reurn series of he SZB-SZA and he SZB-HK pairs is rejeced, poining o he need for furher invesigaion of he dynamics of he SZB marke. 6 In shor, inerrelaionships among hese hree markes are very similar o hose among he SHA, SHB, and HK sock markes: here are bi-direcional volailiy spillover effecs beween SZB-SZA and beween SZB-HK and only a unidirecional volailiy spillover effec from he SZA marke o he HK marke. Similarly, we find ha he SZA marke is he mos influenial among he hree markes: i no only passes reurn realiaions o he HK marke, bu i also leads he ransmission of informaion abou volailiy. Moreover, among HK-SZA, SZB-SZA, and SZB- HK, only one side of he conneced markes is characeried by a parial adjusmen process o reurn o 6 We ried oher specificaions for he mean equaion for he SZB reurn series, bu he resuls do no improve. I could be due o spurious correlaions wih some missing variables. 4

17 long-run equilibrium. We find ha he HK marke is capable of adjusing is disequilibrium posiions o he SZA marke and he SZB marke adjuss in response o disequilibrium wih boh he SZA and HK markes Analyses of dynamic correlaions Having modeled he long-erm equilibrium, shor-erm adjusmen, and spillover effecs across hese markes, i is of ineres o analye he effecs of changes in financial policy and economic condiions on he dynamic correlaions beween he markes. By visual inspecion of hese figures, we idenify wo ineresing poins. 8 Firs, afer February 200, he correlaions beween he SHA-SHB and SZA-SZB markes show an upward rend over ime. This paern may be aribuable o he more liberal governmenal policy allowing domesic ciiens who inves in A-share markes o inves in B-share markes. Second, he ime-varying correlaion coefficiens show differen paerns of evoluion during he Asian financial crisis, which sared in early July 997. For example, from lae 997 hrough early 998, we find ha he correlaions beween any of he A-share markes and he HK or B-share markes decrease. However, he correlaions beween any of he B-share markes and he HK marke increase. 7 I is of ineres o compare he speeds of adjusmen across differen markes. Our evidence shows ha he SHB marke has a faser speed of adjusmen in response o disequilibrium wih he SHA (α=-0.824) han i does wih he HK marke (α=-0.636). Similarly, he SZB marke adjuss faser in response o disequilibrium wih he SZA (α=-0.48) han i does wih he HK marke (α=-0.360). One possible reason for his phenomenon is ha all of he companies lised on he SHB and SZB markes belong o local Chinese companies. Thus, heir price discovery process relaive o A-share markes is more efficien han heir price discovery process relaive o he HK sock marke. 8 We invesigaed he ime-varying condiional correlaion coefficiens esimaed from he FIVECM-BEKK model for each pair of markes. The figures are no shown o save space. However, hey are available upon reques. 5

18 In ligh of hese observaions, we examine he ime-varying correlaion coefficiens in response o unusual marke condiions, such as a financial crisis and changes in regulaion. Expressing his noion in a regression model, we wrie: ij, d 0 dcrisis d 2crisis2 d 3 FP (5) where ij, are he condiional correlaion coefficiens beween Markes i and j; crisis and crisis2 are dummy variables, denoing he early sage (7/2/997-0/5/997) and he effecive sage (0/22/997-2/28/998) of he Asian financial crisis, respecively, 9 and FP is a dummy o capure he impac of he removal of he resricion on invesmen in B shares (2/22/200-2/28/2005). The dummy variables are se o uniy o indicae he presence of an effec and are ero oherwise. The esimaed coefficiens for Equaion (5) are repored in Table 5. The evidence shows ha he indicaor of he effec of he Asian financial crisis, d, is posiive for he six pairs of markes. Thus, in he early sage of he crisis, 7/2/997-0/5/997, he effec was no fully hiing hese six markes. They end o be correlaed wih each oher a a bi higher level. However, from HK and Chinese invesors poin of view, he crisis ook effec on Ocober 20, 997. This led o he negaive and highly significan d 2 for HK-SHA, SHB-SHA, HK-SZA, and SZB-SZA. In conras, he conagion effec spread he crisis o he HK and wo B-share markes, which led o herding, as evidenced by a posiive correlaion and significan d 2 on he SHB-HK pair. The evidence suggess ha he marke segmenaion policy imposed by he 9 Alhough he crisis originaed in Thailand and he marke declined sharply in June 997, followed by he collapse of he Indonesian marke in Augus, no serious aenion was given o hese markes unil he crisis hi he Hong Kong marke in mid-ocober (beween Ocober 20 and Ocober 23 he Hang Seng Index dipped by 23%). From he perspecive of Chinese sock invesors, he Hong Kong marke crash in mid-ocober was a direc hrea o heir invesmens, since he porfolio performance in he B-share markes is perceived o be highly correlaed wih ha of Hong Kong s marke and Shenhen B shares are measured in HK dollars 6

19 Chinese auhoriy is an effecive insrumen for shielding he A-share markes from exernal urbulence. The coefficien of he FP variable, d 3, is significanly posiive for SHB-SHA and SZB-SZA, indicaing ha he correlaions beween A- and B-share markes increased afer domesic invesors in A-share markes were allowed o purchase B shares. Ineresingly, we find ha d 3 for HK-SHA and HK-SZA is also posiive and highly significan, suggesing ha even domesic invesors in A-share markes are sill no allowed o inves in he HK marke and heir paricipaion in B-share markes ends o simulae acive ransmission of informaion beween he A-share and he HK markes. We conclude ha his more relaxed policy on purchasing B shares helped o accelerae he marke inegraion process of A-share markes wih inernaional financial markes. In conras, we find ha d 3 for SHB-HK is negaive and highly significan, suggesing ha he paricipaion of domesic ciiens in SHB is less efficien in ransmiing informaion beween he SHB and he HK marke and, consequenly, reduces he correlaion beween hese wo markes. 5. Conclusions In his sudy, we apply a relaively novel FIVECM-BEKK GARCH framework o examine he long-erm equilibrium, shor-erm adjusmen, and spillover effecs among six pairs of sock markes, namely, HK-SHA, SHB-SHA, SHB-HK, HK-SZA, SZB-SZA, and SZB-HK. Our FIVECM approach is considered o be more general han he radiional VECM approach, since i can measure he effec of he long 7

20 memory on he coinegraing relaionship, which is imporan for revealing he rue relaionships beween he relevan sock markes. Furhermore, augmening he FIVECM wih a bivariae BEKK GARCH formulaion, we invesigae he mean and volailiy spillover effecs across hese markes simulaneously. Our equilibrium analyses indicae ha all six pairs of markes are fracionally coinegraed. The Hong Kong sock marke adjuss o reurn o equilibrium wih he wo A-share sock markes, while he wo B-share markes adjus o reurn o equilibrium wih he corresponding wo A-share markes and he Hong Kong marke. The volailiy spillover effec shows ha here are bi-direcional volailiy spillovers beween he wo A-share markes and he wo B-share markes and beween he wo B-share markes and he Hong Kong marke. However, only unidirecional volailiy spillover effecs from he wo A-share markes o he Hong Kong marke are presen. Among he alernaive markes, we find ha he wo A-share markes are mos influenial in boh mean and volailiy spillover effecs. Furher invesigaion of he dynamic pah of correlaion coefficiens suggess ha relaxaion of governmen resricions on he purchase of B shares by domesic residens increases he correlaion beween he wo A- and he wo B-share markes, indicaing ha he degree of segmenaion has been moderaed and ha he wo classes of markes have ended o gradually merge. Evidence also shows ha his liberal policy acceleraed he marke inegraion process of he A-share markes wih he Hong Kong sock marke. Finally, we find ha he effecs of he Asian crisis on he sock-reurn dynamic correlaions vary across hese markes. 8

21 References Baillie, R., 996. Long memory processes and fracional inegraion in economerics. Journal of Economerics 73, Cai, J., Li, Y., Qi, Y., The day-of-week effec: new evidence from he Chinese sock marke. Chinese Economy 39, Chakravary, S., Sarkar, A., Wu, L., 998. Informaion asymmery, marke segmenaion and he pricing of cross-lised shares: heory and evidence from Chinese A and B shares. Journal of Inernaional Financial Markes, Insiuions and Money 8, Chiang, T.C., Tan, L., Li, H., Empirical analysis of dynamic correlaions of sock reurns: evidence from Chinese A-share and B-share markes. Quaniaive Finance, forhcoming. Cheung, Y., Lai, K., 995. A search for long memory in inernaional sock marke reurns. Journal of Inernaional Money and Finance 4, Ding, Z., Granger, C. W.J., Engle, R. F., 993. A long memory propery of sock marke reurns and a new model. Journal of Empirical Finance, Engle, R., Granger, C., 987. Coinegraion and error correcion: represenaion, esimaion and esing. Economerica 55, Engle, R.F., Kroner, K.F., 995. Mulivariae simulaneous generalied ARCH. Economeric Theory, Kim, Y., Shin, J., Ineracions among China-relaed socks. Asian-Pacific Financial Markes 7,

22 Laurence, M., Cai, F., Qian, S., 997. Weak-form efficiency and causaliy ess in Chinese sock markes. Mulinaional Finance Journal 4, Li, Y., Yan, D., Greco, J., Marke segmenaion and price differenials beween A shares and H shares in he Chinese sock markes. Journal of Mulinaional Financial Managemen 6, Lo, A. W., 99. Long-erm memory in sock marke prices. Economerica 59, Saikkonen, P., 99. Asympoically efficien esimaion of coinegraing regressions. Economeric Theory 7, -2. Sock, J. H., Wason, M.W., 993. A simple esimaor of coinegraing vecors in higher order inegraed sysems. Economerica 6, Wang, S.S., Firh, M., Do bears and bulls swim across oceans? Marke informaion ransmission beween greaer China and he res of he world. Journal of Inernaional Financial Markes, Insiuions and Money 4, Yeh, Y.H., Lee, T., Pen, J., Sock reurns and volailiy under marke segmenaion: he case of Chinese A and B shares. Review of Quaniaive Finance and Accouning 8,

23 Table Descripive saisics for Chinese sock indices and he Hang Seng index SHA SHB SZA SZB HK Mean Median Maximum Minimum Sd. Dev Skewness Kurosis Noe: These are descripive saisics of he logarihms of sock indices. Sample covers January 995 hrough December The oal number of observaions is

24 Table 2 Long memory ess on coinegraion residuals Residual series Modified Range Over Sandard Deviaion (R/S) es Tes saisic P-value HK SHA P<0.05 SHB SHA 3.55 P<0.0 SHB HK P<0.0 HK SZA.95 P<0.05 SZB SZA P<0.0 SZB HK 4.35 P<0.0 Noe: The residual series are consruced using Equaion () in he ex. Superscrip sands for a dependen variable and subscrip for an independen variable. 22

25 Table 3 ARFIMA fi resuls Residual series d ARFIMA(p,d,q) AR() HK SHA 0.093(0.046)** 0.967(0.05)*** SHB SHA 0.064(0.037)* 0.99(0.006)*** SHB HK 0.00(0.039)*** 0.988(0.008)*** HK SZA 0.02(0.046)** 0.966(0.05)*** SZB SHA 0.7(0.04)*** 0.982(0.00)*** SZB HK 0.2(0.044)*** 0.972(0.04)*** Noe: The residual series are consruced using Equaion () in he ex. Superscrip sands for a dependen variable and subscrip for an independen variable. Numbers in parenheses are sandard errors. Selecion of AR (lag) and MA (lag) erms, p and q, is based on he examinaion of ACF, PACF, and Bayesian Informaion Crierion (BIC). ***, ** and * indicae significance a he %, 5% and 0% level, respecively. 23

26 Table 4 Esimaes for FIVECM-BEKK (, ) model Panel A: Esimaed resuls HK-SHA SHB-SHA SHB-HK HK-SZA SZB-SZA SZB-HK c (0.00)* (0.002) (0.002) (0.00)* (0.002) (0.002) c (0.00) (0.00) 0.00 (0.00) (0.002) (0.00) (0.00) 0.729(0.289)*** 0.885(0.440)** 0.650(0.342)** 0.676(0.282)** (0.284)* 0.460(0.83)*** (0.074)*** (0.294)* (0.058) (0.06)*** (0.72) (0.48) (0.253) (0.300) (0.20) (0.324) (0.39) (0.098) (0.075) (0.203) (0.049) (0.074) (0.098) 0.09 (0.078) (0.286)*** (0.444)* (0.354)* (0.280)** (0.284)* (0.95)* (0.252) (0.302) (0.200) 0.88 (0.325) (0.43) (0.097) A(,) (0.002)* 0.04 (0.002)*** 0.08 (0.002)*** (0.002) 0.03 (0.002)*** 0.04 (0.002)*** A(2,) (0.003)*** (0.00)*** (0.002) 0.00 (0.006)* 0.00 (0.00)*** (0.00) A(2,2) (37.495) (8.743) (27.68) 0.00 (0.077) (0.002) (3.055) ARCH(,) (0.033)*** (0.036)*** (0.036)*** (0.028)*** (0.03)*** (0.023)*** ARCH(,2) (0.028)** 0.32 (0.05)*** -0.46(0.060)*** (0.023)* 0.85 (0.040)*** (0.049)*** ARCH(2,) 0.00 (0.055) 0.06 (0.023)*** (0.027)** (0.062) 0.08 (0.027) (0.02) ARCH(2,2) (0.032)*** (0.028)*** (0.042)*** (0.040)*** (0.034)*** 0.56 (0.035)*** GARCH(,) (0.00)*** (0.09)*** 0.83 (0.033)*** (0.007)*** (0.03)*** (0.05)*** GARCH(,2) (0.009)*** (0.02)** (0.035)*** (0.009)*** -0.03(0.05)*** (0.023)* GARCH(2,) (0.05) (0.00)*** (0.08)*** (0.05) (0.02)** 0.09 (0.008)** GARCH(2,2) 0.940(0.04)*** (0.00)*** (0.04)*** (0.09)*** (0.06)*** (0.007)*** 24

27 Panel B: Model diagnosic saisics LB (0)-HK 8.09 NA NA LBS (0)-HK 7.68 NA NA LB (0)-SHA NA NA NA NA LBS (0)-SHA NA NA NA NA LB (0)-SHB NA NA NA NA LBS (0)-SHB NA NA NA NA LB (0)-SZA NA NA NA NA LBS (0)-SZA NA NA NA NA LB (0)-SZB NA NA NA NA *** ** LBS (0)-SZB NA NA NA NA * Noe: The esimaes are based on Equaions (3) and (4) in he ex. The dependen variable in each model is marked in bold. The firs-order ARCH(i,j) and GARCH(i,j) erms are he elemens of he ARCH and GARCH coefficien marices A and B in Equaions (4) Numbers in parenheses are sandard errors. ***, ** and * indicae significance a he %, 5% and 0% level, respecively. LB (0) and LBS (0) are he Ljung-Box saisics based on he level and he squared level of he ime series up o he 0 h lag. 25

28 Table 5 Effecs of crisis and policy change on condiional correlaion across Chinese segmened sock markes and Hong Kong sock marke Esimaes Markes HK-SHA SHB-SHA SHB-HK HK-SZA SZB-SZA SZB-HK d (0.00) 0.437(0.00)*** 0.94(0.009)*** 0.024(0.009)*** 0.442(0.02)*** 0.94(0.00)*** d 0.45(0.042)*** 0.078(0.04)* 0.023(0.036) 0.72(0.038)*** 0.033(0.050) 0.6(0.039)*** d (0.023)*** (0.022)*** 0.220(0.020)*** (0.02)*** (0.027)*** 0.007(0.02) d (0.05)*** 0.244(0.04)*** (0.03)*** 0.22(0.03)*** 0.90(0.07)*** 0.024(0.04)* Noe: The esimaes are based on Equaion (5) in he ex. Numbers in parenheses are sandard errors. ***, ** and * indicae significance a he %, 5% and 0% level, respecively. 26