The impact of Asian crisis on market integration: evidence from East Asian real interest rates

Abstract

This article examines the linkage of real interest rates for a group of East Asian countries. Monthly real interest rates data are considered for the USA, Japan, Korea, Singapore and Thailand from 1980 to 2005. It is found that the degree of capital market integration has increased after the Asian financial crisis in 1997. Before the crisis, both the US and Japanese capital markets dominated the region. After the crisis, the dominance of the Japanese market has completely disappeared while the US market remains the sole dominant player. Also it appears that Korea was insulated from the regional market influence before the crisis.

Acknowledgement

The author expresses gratitude to the Department of Accounting and Finance, Monash University, for its financial assistance with this research project.

Notes

¹The monthly money market rate is used for Korea and Thailand and the T-bill rate for the US. For Japan, the call rate is chosen while the interbank rate has been used for Singapore. Short-term interest rates are used for these countries. Long-term rates have been examined but the results are quantitatively similar to and qualitatively same as short-term rates.

²All real rates appear to be integrated of order 1 at the 5% level of significance according to the augmented Dickey–Fuller test. Robustness of the results that all rates are I(1) has been tested using alternative unit root tests including Phillips–Perron test and KPSS test. These tests produce unanimous conclusion of and strong support for I(1) in both Periods 1 and 2. Also the VAR order is estimated using Bayesian Information Criterion (BIC). To determine the co-integration rank and estimate the unknown parameters in the vector error correction model, Johansen's (1988) method is used. The trace and maximal eigenvalue tests of Johansen (1988) are used to determine the cointegration rank.

³Recent history supports the argument for the isolation of the Korean market in the pre-crisis period. Korea had been undergoing a gradual opening of the financial market until the financial crisis for which the country had to liberalize financial markets under the International Monetary Funds (IMF) bailout program in a far more extreme fashion than ever before. Effectively the country kept its market closed to foreign investors until the late 1980s when measures were taken to abolish restrictions on current account transactions. It was then early 1990s when foreigners gained a limited access to participation in the Korean market. Not long after this, Korea had to open the market more rapidly as a part of membership requirements to join the OECD. Eventually restrictions on foreign stock ownership were lifted in 1998 together with a complete liberalization of short-term money market instruments (see Harvie and Lee, 2003). From these historical facts it is a fair conjecture that Korea had been independent of the world market influence before the crisis. Visual inspection of the time series plot is somewhat helpful in understanding this. Comparison of Figs 1 and 2 show a notable deviation of the Korean rate from its major market counterparts, US and Japan, in Period 1, whereas Singapore seems to have a strong correlation with US and Japan. Although Thai rate as a recipient of world market shock is highly volatile, it shares local trends with US and Japan.

Fig. 1. Time series plot of Singaporean, Thai, Japanese and US rates (Period 1)

Fig. 2. Time series plot of Korean, Japanese and US rates (Period 1)

⁴ The US responds to error correction term but preliminary analysis indicates this is not robust to lag choice and variable inclusion.

⁵ According to preliminary analysis, as in Period 1, the US response to error correction term is not robust to lag choice.