CHEER and markets’ integration: evidence from selected East Asian economies
| Date | 16 July 2024 |
| Pages | 152-169 |
| DOI | https://doi.org/10.1108/JCEFTS-01-2024-0002 |
| Published date | 16 July 2024 |
| Author | Minoas Koukouritakis |
CHEER and markets’integration:
evidence from selected East
Asian economies
Minoas Koukouritakis
Department of Economics, University of Crete, Rethymnon, Greece
Abstract
Purpose –This paper aims to investigate markets’integration using the capital enhanced equilibrium
exchangerate (CHEER) model for seven, highly competitive, East Asian countries.
Design/methodology/approach –The sample consists of monthlyobservations, whereas unit root and
cointegrationtechniques with structural shiftshave been used.
Findings –The evidence shows that the weak form of the CHEER approach holds for Malaysia and
Thailand. For China, Japan, Korea, Singapore and Taipei, only the uncovered interest parity condition is
validated, implying capital markets integration. In contrast, for these five countries, the results indicate
absence of goods’markets integration. This outcome can be attributed to the impact of quitehigh non-tariff
barriersand the Balassa–Samuelson effect.
Originality/value –To the best of the author’s knowledge,this is the first study that investigate markets’
integrationin several East Asian economies, usingthe CHEER approach and more accurateprice indices.
Keywords East Asian economies, CHEER, Structural breaks, Cointegration,
Capital and goods’market integration
Paper type Research paper
1. Introduction
The 1997 Asian financial crisis is referredas a benchmark for the economies of the region. It
began in July 1997, when Thailandended the currency peg to the USDand devalued its
currency to cope with the speculativepressures. During the next months, this crisis affected
Malaysia, the Philippines, Indonesia, Hong Kong and the Republic of Korea. This led to a
significant slowdown of capital inflows to the countries of the region, which reduced
investment and, thus,deteriorated economic growth.
In the aftermath of this crisis, most East Asian countries tried to modernize their financial
sectors and to strengthen the linkages with the other economies of the region. These efforts led
to significant developments of their capital markets and increased the soundness of their
banking sectors. Financial policy coordination had also been strengthened, as expressed by
several arrangements regarding macroeconomic monitoring and liquidity support (e.g. the
Chiang Mai Initiative in 2000 and the Asian Bond Market Initiative in 2003). Eventually, all
these efforts were aimed at deepening the markets’integration of these countries to avoid the
effects of similar crises in the future. Of course, the re spective exchange rates were also affected.
Therefore, the investigationo ftheir determination becomes quite interesting.
JEL classification –F15, F31, F41
Author wish to thank the editor and an anonymous referee for their constructive comments that
improved the quality of this paper. The remaining errors are my own
JCEFTS
17,2/3
152
Journalof Chinese Economic and
ForeignTrade Studies
Vol.17 No. 2/3, 2024
pp. 152-169
© Emerald Publishing Limited
1754-4408
DOI 10.1108/JCEFTS-01-2024-0002
The current issue and full text archive of this journal is available on Emerald Insight at:
https://www.emerald.com/insight/1754-4408.htm
Most approaches regarding exchange rate determination require a plethora of data,
which may not be available for emerging economies (as most of the sample countries). For
avoiding this problem, Juselius (1991,1995) and Johansen and Juselius (1992) developed an
approach that combines the uncovered interest parity (UIP) and the purchasing power
parity (PPP) conditions. This approach is the capital enhanced equilibrium exchange rate
(CHEER) (MacDonald,2007) and its theoretical framework is analysed in Section 3.
The present study uses this approach for seven, highly competitive, countries of the region,
namely, China, Japan, Republic of Korea (henceforth, Korea), Malaysia, Singapore, Taipei,
China (henceforth, Taipei) and Thailand [1]. These countries implemented different exchange
rate regimes (free-floating in Japan, Korea and Malaysia, and managed floating in China,
Singapore, Taipei and Thailand), whereas they managed to recover rapidly from the Asian
crisis by promoting financial policy coordination and reforming their economic institutions
towards markets’liberalization.
This study contributes to the relevant literature in several ways. Firstly, to my
knowledge, it is the first study that investigates markets’integration in several East Asian
economies the CHEER approach. Secondly, it uses advanced cointegration techniques that
allow for structural shifts in the data. Such shifts are quite important because international
economic events, such as the 2007–2009global financial crisis, or country-specific economic
policies and reforms are likely to have affected the level and trend of the variables under
consideration. Thirdly,it extends the theory regarding the formulation of the CHEER model.
In particular, this model implies two long-run relationships, whereas the current analysis
extends the analysis to the case of a single long-run relationship and the subsequent
modification of the theoretical hypothesis. Fourthly, unlike all other studies, it uses more
accurate price indices.These constructed traded-goods price indices (TPIs) avoid non-traded
goods prices that may negativelybias the empirical validation of the PPP.
As it is discussed analytically in Section 6, the empirical findings reflect the successful
economic reforms that these countries implemented the past two decades, to integrate their
capital markets into the global financial system. In contrast, there is absence of goods’
markets integration. High non-tariff barriers that remain, as well the Balassa–Samuelson
effect, may possiblyexplain the latter result.
Section 2 reports the literature review, whereas Section 3 describes the theoretical
framework of the CHEER model. Section 4 illustrates the econometric methodology and
Section 5 describes the data. Section 6 reports the empirical findings and provides some
policy implications,whereas Section 7 concludes.
2.Literature review
The literature regardingthe theoretical models of exchange rate determination is quite large.
Among others, Williamson (1985) proposed the medium-run concept of fundamental
equilibrium exchange rate,which indicates that the exchange rate is at its equilibrium value
only when it satisfies the condition of simultaneousinternal and external balance (i.e. when
it equates the current account at full employment with sustainable net capital flows).
Bayoumi et al. (1994) presented the desired equilibrium exchange rate, whereas Stein (1994)
developed the natural real exchange rate that is consistent with simultaneous internal and
external balance and corresponds to the rate that occurs if speculative and cyclical factors
are removed and unemploymentis at its natural rate. Likewise, Clark and MacDonald (1998)
proposed the behavioural equilibrium exchange rate and the permanent equilibrium
exchange rate. The former modelimplies that the equilibrium rate is designated by the long-
run behaviour of the macroeconomic variables, whereas the latter model indicates that the
exchange rate isa function of the variables that have a persistenteffect on it [2].
CHEER and
markets’
integration
153
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