Financial development, international trade, and stock market integration, evidence in six southeastern asia countries

Financial development, international trade, and stock market integration: Evidence in six Southeastern AsiaCountries NGUYEN HOANG THUY BICH TRAM University of Economics HCMC – nhtbtram@u

Financial development, international trade, and stock market integration: Evidence in six Southeastern Asia

Countries

NGUYEN HOANG THUY BICH TRAM

University of Economics HCMC – nhtbtram@ueh.edu.vn

LAM HUYNH ANH

Vietnam Joint Stock Commercial Bank for Industry and Trade –

huynhanh.ueh@gmail.com

Abstract

Measuring the integration degree of the national stock market ispopular in general globalization trend The paper applies themeasurement method of Chaiporn (2016) to consider for Vietnamstock market, and other five Asia typical economies in the periodfrom 2000 to 2015 Their method has foundation on the research ofWälti (2011), An and Zhang (2013), Dasgupta (2010) The paperadopted fixed effect and random effect models to measure theimpacts of financial development, financial integration andinternational trade integration to national stock market integration.The research findings revealed the positive affect of the financialintegration and development to the national stock marketsintegration with global stock market in Vietnam and other fivecountries Beside, international trade integration does not effect tointegrating securities market Perhaps, the bilateral trade is too small

to impact the bilateral stock markets integration

Keywords: financial development; financial integration;

international trade integration; Southeastern Asia stock markets

integration

1 Introduction

The globalization trend creates a tremendous impetus not only topromote the financial development of a country, but also to opennew abroad investment opportunities for international investorsdiversify their portfolio and risk management under control Besides,

international trade activities through exchanging goods betweencountries has

been developed in parallel with the growth in transportation,infrastructure, multinational companies as well as humanresource In the general context of the world, the members ofAssociation of Southeast Asian Nations (ASEAN) have reached thestep towards joining the World Trade Organization (WTO), the freetrade agreement (FTA), plus the ASEAN economic communityfounded in 2015 with the important commitment in trade andnon-trade area The main economic events help ASEAN membercountries significantly improve in the financial development andbilateral and multilateral trade integration.

Financial development, financial integration, and internationaltrade between countries actually provide many opportunities foreconomic development Besides, the countries also need to build

a strong and effective financial system that creates economicvalue and solid foundation to finance development Conducting in-depth integration further on all areas in general and the stockmarket in specific is necessary

The measure of national stock market integration with globalstock markets is a popular topic in the era of globalization It hasbeen researched in many countries around the world However,Vietnam - one member country of ASEAN is still not yetapproached and studied On the other hand, the economicsituation in the world still has many vulnerabilities The regionaleconomic crisis or economic crisis in some countries still doesn’thave end markers Its influence has spread to Vietnam and ASEANcountries in general It would effects much to the securitiesmarket in those countries, especially, a country on the momentum

of the increasingly broad and deep integration as Vietnam is easy

to be sensitive to the world economy’s volatility

From there, I set out the question of how to measure the stockmarket integration, and whether financial development andinternational trade integration has the positive affects to thenational stock market integration With the aim of researching,the paper want to approach deeply to stock market integrationissue of Vietnam and five typical Southeastern Asia economies(Indonesia, Malaysia, the Philippines, Singapore, Thailand) toanswer the questions

2 Literature review

Many authors studied the influence of financial development andfinancial integration Typically, Giné and Townsend (2004) used thepanel data method for 394 companies in

13 developing countries in the period 1988 - 1998 to estimatediversified investment portfolio model, and showed that capitalmarket liberalization impacts to each company differently,depending on its scale Before the events of global financialintegration, the small scale companies had been more difficultfinancially than the large scale ones Thanks to the events, somebarriers to foreign capital flows which severed as a cushion tosmall companies had been removed Smaller companies willaccess sources of capital better while larger ones will lose theconcessional credit package from the integration So, the authorclaimed that the capital market liberalization will improve thisproblem, and they show that it is necessary to allocate efficientlyand to be fair in financial resources to stimulate growth andcreate higher production value for the country.

Umutlu et al (2010) also considered that the level of financialmarket liberalization affects the level of fluctuation of stock return

by considering the time-varying degree of integration The authoralso examines additional factors such as the financial opennessand the crisis in the region Then, they provide empirical evidencesupporting to that the more increasing the degree of financialintegration is, the more decreasing the level of fluctuation of theoverall stock portfolio returns is

A few other studies have also shown that the stock market doesnot completely integrate between countries and the level ofintegration is different over time Typically, Morelli (2010) studiesthe level of stock market integration in 15 Member States of theEuropean Union in the period 1995-2007 The integration ismeasured by multiple element asset pricing model The resultsshowed that the level of stock market integration is not completebetween the securities markets of the Member States

In the context of Asian countries, Chambet and Gibson (2008)estimated the level integration of financial markets bymultivariate GARCH models They evaluated the level ofintegration and system risk in emerging markets The authorspointed out that the emerging markets still have not been stableand level of financial integration has been decreased significantlyduring the financial crisis in the 1990s because of the collapse ofthe stock market Besides, the authors are interested in therelationship between the level of international trade and financial

integration level of a nation The empirical results showed that thecountry with a diversified trade structure has the reverse impact

to stock market integration

Some recent studies have related to the level of stock marketintegration in the globalization trend For example, Ilyes, Olfa,Khaled (2014) put more factors relating to global economicintegration in 5 South Asian regional markets where have 4members of ASEAN - Malaysia, Thailand, Singapore, Indonesia Byusing international capital asset pricing model (ICAPM), theauthors find that the integration, opening has impacted the level

of stock market integration considerably over time and theportfolio diversification is increasingly popular and generatesignificant profits

Similarly, Aviral et al (2013) used the cross correlation method toshow that the level of stock market integration in 9 countries in Asia

is still low, so that there have not been much potential growth of thediversified international portfolio in the long term On the other hand,Chaiporn et al (2016) used the unbalanced panel data related tofinancial integration and trade integration in Asian developed anddeveloping countries in the period 1985-2013 Their empiricalevidences support for the significant impact of financial integration

to stock market integration more than international trade integration

In terms of the ASEAN region, Reid Click, Michael (2003)measured the level of stock market integration of 5 countries -Indonesia, Malaysia, the Philippines, Singapore, and Thailand afterthe Asian financial crisis in the period 1998-2002 They collectedstock prices return rate daily and weekly Their results show thatthese countries are not integrated completely in the post-crisisperiod These authors also give advice on integration policy inorder to promote investors to find out the appropriate channel forfinancial capability, investment needs, and appreciate theopportunity that stock integration brings about high liquidity andlow transaction costs Then, that would be motivation to integratestock markets between member countries in the ASEAN region inparticular and integrate the global economy more deeply andwidely in order to take advantage of the potential opportunitiesand competitive advantages in the long term

3 Method

3.1 Data

The main data sources are World Bank (WB), InternationalMonetary Fund (IMF), Stock Market Quotes & Financial News

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Some variables such as the level of individual stock marketintegration with global stock markets (SMI), the level of bilateralstock market integration (BSMI) are calculated from data on StockMarket Quotes & Financial News

Financial development (FD), the degree of international tradeintegration between country i and the world (ITI) and the level ofbilateral trade exchange (BITI) are from the IMF

GDP growth rate (∆ GDP), natural logarithm local currency valuecompared with the dollar (RETFX), the level of financial integration(FO) and the interest rate spread (INTSPREAD) are from WB.Beside, stock market development variables (SMD1 and SMD2)are measured differently to check the model’s robustness SMD1

is the ratio of domestic firms’ market capitalization to GDP SMD2

is the ratio of trading stock value to GDP Both of them are alsofrom WB

The paper is done in 6 typical countries in ASEAN such asVietnam, Indonesia, Malaysia, the Philippines, Singapore, Thailand

in the period from January 2000 to December 2015

3.2 Methodology

The paper examines 3 hypothesis:

H1: the level of financial development (FD) impacts in the samedirection to the level of stock market integration with global stockmarkets (SMI)

H2: the level of international trade integration (ITI) impacts inthe same direction to the level of stock market integration withglobal stock markets (SMI)

H3: the level of bilateral international trade integration (BITI)impacts in the same direction to the level of bilateral stock marketintegration (BSMI)

To test the hypotheses H1 and H2, the research based onChaiporn et al (2016) models, linear regression is done throughthe equation:

$,& = $ + , $,&/, + 0 $,&/, + 3;0: 3$,&/, + &

where:

$,& ∶ the level of stock market integration between country i and the global stock market at time

t The index is calculated as follows:

First of all, R-square (R2) is calculated from the equation:

$,> = $ + , ?,> + $,>

The coefficient R2 shows the dependence of the stock return rate of a country i ( $,> ) on the international stock return rate ( ?,> ), and the volatility in term of characteristic elements of country i on day k The daily stock return rate is calculated by first differencing the natural logarithm of stock indicators to estimate the equation (2) for each country The paper also tests the stability of the model by using monthly stock return rate data instead of daily data in the calculation of the equation (2)

Then , the SMI index is calculated by taking the natural

FDi,t : the level of financial development in country i at time t Itmeasures the level of financial development through the level ofbanking system development FD is calculated by the percentage ofdomestic credit financed by financial markets on total GDP (%)

ITIi,t : the level of international trade integration in country iwith the world at time t ITI is measured by percentage of exportand import on the total GDP (%)

CONTROL is a matrix of variables to control at the nationallevel: ∆GDP, RETFX, INTSPREAD và FO

∆GDP: GDP growth rate (%)

RETFX: Exchange rate return (%) is the natural logarithm of thelocal currency value compared with the dollar If RETFX is positive,

it expresses the currency appreciation of that country

FO: Financial openness is the level of financial integrationdirectly related to the level of capital market liberalization It isexpressed by the ratio of foreign direct investment (FDI) of GDP(%)

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INTSPREAD: Interest rate spread (%) controls the effect of theinterest rate disparity between countries It is calculated by usingthe interest rate disparity between country i and US moneymarket interest rates The INTSPREAD will be very small, even 0 ifthe interest rate of country i is equal to the world interest rate –the US interest rate The value of INSPREAD indicates theincomplete domestic financial market integration or no integrationwith the world financial markets

t : standard error

To test the hypothesis H3, the paper measures the integration

of bilateral stock market and the integration of bilateralinternational trade through equation (4):

$,> = $ + , ?,> + 03,> + $,>

where,

i,t : standard error.

Then, the degree of integration of the bilateral stock market (BSMI)

estimated from equation (4):

C F

Similarly to SMI, the paper also test the stability of the model

by using the monthly stock return rate instead of daily data in thecalculation of equations (4) and (5)

Finally, the integration of bilateral international trade (BITI)between country i and j is measured by the relative proportions ofexports from country i to country j in the total exports of country i,and the relative proportion of imports by country j from country i

in the total imports of the country i in year t:

$3,& =

4 Results

4.1 Descriptive statistics

A total of 96 observations for all variables represent the level ofstock market integration, the integration of international trade,development and financial integration Most of the variables havevery small standard errors, SMD1, SMD2, BSD, ITI exception Thedifferences in the development of the banking system and foreigntrade are relatively large between 6 countries in the ASEANregion

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SMD1, SMD2, FO and ITI was judged to have significantly high

correlation levels, and a few other explanations variables have

weak correlation phenomenon To illustrate the degree of stock

market integration with global stock market, the paper process of

graphing R2 of the equation (2) estimated by daily stock return in

the below picture

0.25

0.2

R2_INDO0.15

R2_MAY R2_PHI