The paradox of China's international stock market co‐movement. Evidence from volatility spillover effects between China and G5 stock markets
| DOI | https://doi.org/10.1108/17544401011084316 |
| Published date | 05 October 2010 |
| Date | 05 October 2010 |
| Pages | 235-253 |
| Author | Yusaku Nishimura,Ming Men |
| Subject Matter | Economics |
China and
G5 stock
markets
235
Journal of Chinese Economic and
Foreign Trade Studies
Vol. 3 No. 3, 2010
pp. 235-253
#Emerald Group Publishing Limited
1754-4408
DOI 10.1108/17544401011084316
The paradox of China’s
international stock market
co-movement
Evidence from volatility spillover effects
between China and G5 stock markets
Yusaku Nishimura and Ming Men
School of International Trade and Economics,
University of International Business and Economics,
Beijing, People’s Republic of China
Abstract
Purpose – The purpose of this paper is to examine the daily and overnight volatility spillover effects
in common stock prices between China and G5 countries and explain their implications on the basis
of empirical results.
Design/methodology/approach – The analysis utilizes the exponential generalized autoregressive
conditional heteroskedasticity (EGARCH) model, the cross-correlation function approach, and
realized volatility for daily and intraday stock price data that cover the period from January 5, 2004 to
December 31, 2007.
Findings – Principally, the paper concludes the following: strong evidence of short-run one-way
volatility spillover effects from China to the US, UK, German and French stock markets is observed
and the test results indicate that Chinese investors were not rational and China’sstock market entered
a speculative bubble period after the second half of 2006.
Originality/value – Contrary to widespread belief, the empirical results suggest that a small (China)
stock market has significant influence on a large (G5) stock market but not vice versa. This paradox
is interpreted as a particular phenomenon existing together with the rapid economic development and
severe capital regulation in China.
Keywords Stock markets, Volatility, Information systems, China
Paper type Research paper
1. Introduction
On February 27, 2007, the Shanghai Composite Index and Shenzhe n Component Index
fell by 8.84 and 9.29 percent, respectively, which was the largest one-day percentage
decline in China’s stock market in the last decade. This ‘‘China shock’’ spread
throughout the global financial markets quickly and led to a simultaneous drop in
global stock prices. This event raised concerns about whether China had entered a new
development stage and whether China’s economy had started to play an important role,
not only in the field of international trade, but also in international finance.
Market deregulation and liberalization have increased the globalization of financial
markets, which in turn affects the interdependence of asset prices across these markets.
Along with the advances in econometrics and the availability offrequency data, studies
on the nature of relationships among stock price movements across markets have been
attracting more academic attention over the past two decades. Many papers have
empirically studied the co-movement of stock prices across international markets.
Hamao et al. (1990) analyzed return and volatility spillover effects around the Black
Monday stock market crash of 1987 in the context of the USA, the UK and Japanese
stock markets over the three-year period from April 1, 1985 to March 31, 1988. They
divided dailyclose-to-close returns into their close-to-open and open-to-closecomponents
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in order to analyze the spillover effects on the opening price and on prices after the
opening of trading separately. They defined the foreign market volatility as the squared
residual derived from an MA(1)-GARCH(1,1)-M model[1] (referred to as ‘‘volatility
surprise’’), and appended it to the domestic market’s conditional variance specification.
Evidence of volatility spillovers from the USA toJapan, the UK to Japan and the USA to
the UKwas observed, but no volatility spillover effects in other directions were found for
the pre-October1987 period.
Watanabe (1996) studied return and volatility spillover effects from the UK and the
USA to Asian stock markets[2] by using the daily closing stock price from February 8,
1990 to June 27, 1994. The volatility was calculated based on the volatility estima tion
procedure proposed by Schwert (1990). Regression analysis was then used to study
whether there was a spillover effect or not. As for return spillovers, positive and
statistically significant effects were reported from the USA to eight Asian markets
except for Indonesia and from the UK to five Asian markets (Hong Kong, Singapore,
Malaysia, the Philippines and Thailand). With regard to volatility spillovers,
significantly positive effects were reported from the USA to Japan, Indonesia and
Thailand, but there was no significant effect from the UK to other countries.
Moreover, many academic papers have found the existence of international
co-movement of stock markets. Examples include Eun and Shim (1989), Kasa (1992),
Cheung and Mak(1992), Masih and Masih (1999), Ng (2000), Jang and Sul (2002),Hamori
(2003) and Khalid and Kawai(2003). Although these studies analyzedinterdependence of
stock returns and volatility by using different methods, data and sample periods, the
major findings from these studies may be summarized as follows. First, stock markets
throughoutthe world are becoming moreinterdependent in the globalcontext of financial
liberalization and deregulation. Second, the US market can be considered as a ‘‘global
factor’’ and was foundto lead most of the stock marketsat least before the crash of 1987.
Third, there is strong evidence of co-movement among international stock markets
during or immediately aftera crisis, e.g. the Black Monday stock marketcrash of October
1987, the Asian financial crisis in 1997, R ussian government’sdefaul t in 1998, etc.
In recent years, the issue of stock market co-movement between China and
international stock markets has gradually attracted aca demic attention. Han and Xiao
(2005) studied the return spillover effect between China and US stock markets using
the MA(1)-GARCH(1,1)-M model. As per Hamao et al. (1990), their sample consisted of
intraday open-to-close and close-to-open return between J anuary 1, 2000 and December
31, 2004. The results showed very weak return spillover from China to the USA, but no
evidence was found of spillover from the USA to China.
Johansson and Ljungwall (2009) investigated return and volatility spillover effects
among the different stock markets in the Greater China region (China, Hong Kong and
Taiwan) using the multivariate exponential GARCH (EGARCH) model. Their sample
consisted of weekly stockindices on the Dow Jones China 88 (an index that includes the
major stocks listed on the Shanghai and Shenzhen stock exchanges), the Hang Seng
Index and the Taiwan Weighted Index during the period January 5, 1994-December 31,
2005. They found that there was significantspillover effect in both returns andvolatility
among the different markets. However, the China stock market is somewhat lessrelated
to the other two markets.
Lin et al. (2009) estimated the dynamic conditional correlation model proposed by
Engle (2002) to accommodate changing variance, covariance and correlations. They
used weekly stock index returns from December 28, 1992 to December 29, 2006 for the
main Chinese markets (both A-share and B-share), the other five largest Asian markets
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