Literature Review

The present study examines the relation between the volatility of the stock market and
the volatility of macroeconomic variable in Malaysia and Indonesia. A twostep method is
used to analyse the volatility of the target sequence first using the well – know GARCH
model, followed by and analysis of the relationship between market volatility and
macroeconomic variable volatility. The finding of SUR method show the presence of a
significant relationship between stock market volatility and macroeconomic variable
volatility in both countries. Trade openness is the most important macroeconomic factor for
deciding the volatility of the stock market in Malaysia and volatility of CPI exerts the greatest
effect on volatility of the stock market in Indonesia. The disparity between the two countries
result can stem from Indonesia’s energy subsidies and the varying degree of trade openness
and stock market efficiency in both countries. INT has the lowest negative value mean while
M has the highest mean in both national. Though the KLCI first difference showed the
highest standard deviation in Malaysia, INT show the highest standard deviation level in
Indonesia. All series show excess kurtosis in both nations, suggesting that the series in
leptokurtic, KLCI skewedness is negative, EX; INT in Malaysia and IPI in Indonesia,
showing a fatter left side of their distribution as the right side. The Jarque – Bera check of
normality show that all series are different from normal distribution. INT and CPI volatility
show positive and significant impacts on Malaysia stock market volatility, the most important
variable for evaluating the volatility of the Malaysia stock market which is highly significant
and has the highest coefficient value among macroeconomic variable. (Lida Nikmanesh &
Abu Hassan Shaari Mohd Nor, 2016).
 The study by (Morelli, 2002) using a two – stage technique involving first
Generalized Autoregressive Conditional Heteroscedasticity (GARCH) model and second
Ordinary Least Square (OLS) method to determine the predictive power of macroeconomic
volatility in relation to the volatility of the UK stock market and Morelli find the
macroeconomic variables volatility may substitute for just 4.4 % of stock market volatility
variation. (Engle & Rangel, 2008), introduce a spline – GARCH model to estimate low –
frequency data variability for macroeconomic variable in a sample of 50 countries, testing the
relationship between volatility and macroeconomic volatility is then used by panel approach
and SUR process and the finding that the volatility of financial markets is driven by three
macroeconomic variable: inflation, interest rate and real GDP. Investigate the economic
effects and demand growth on market volatility in some Asian countries (i.e, Malaysia, India,
Japan, Philippines and Korea) using GARCH model they find that the impact of inflation on
stock volatility in all countries except Korea is negligible. In addition, the effect of the
production growth on stock volatility in India and Philippines is found to be significant, they
researcher also uses a Markov switching – EGARCH model and show that shifts in exchange
rates significantly affect stock market volatility in four developing countries, namely
Singapore, Hong Kong, Mexico and Malaysia (Habibullah, Baharom, & Kin Hing, 2009;
Walid et al., 2011). The discrepancy attributed to the studies in Asian countries is that when
estimating causes of stock market volatility, no attention has been paid to the connection
between foreign stock markets in Asian countries. However, significant correlation is
expected between the international stock markets located in the same area. The presence of
correlation between international stock markets will influence the results of the estimates,
hence, it is important to use a method that can handle the correlation between stock markets
effectively.
 According Abbas Valadkhahi, S Chancharat and Charles Harvie, (2006), apart from
Singapore, stock return changes in Indonesia and Malaysia were the most significant
determinants of Thailand’s return in pre – 1997 period, but these were replaced by the
Philippines. This change in significance in the post – 1997 period is a consequence of capital
control placed in Malaysia during 1998 and economic integration with Thailand, Philippines
situation, however is harder to understand. Third, none of stock markets in non – regional
countries played an important role in explaining the difference in Thailand stock market
returns before or after 1997. In line with previous research, the influence of macroeconomic
variable on the dependent variable was small, with the only exception being oil price shift.
An increase in oil prices appears to have had a negative impact on stock return before 1997
but was negligible after 1997. Ultimately, the large approximate coefficient for time –
varying conditional variance show that uncertainty itself only had a positive effect on the
return of Thailand stock markets during the pre – Asian crisis.

The main goal of this empirical research was investigated how 15 foreign stock
market and five related macroeconomic variable in Thailand affected monthly stock market
return in the pre and post 1997 Asian crisis, the Singapore stock market was found to have a
major impact on the Thai stock market during both the pre and post 1997 periods. Before
1997, the Indonesian and Malaysian stock market were substantially related to the Thai stock
market, while after the crisis, Korea and the Philippines played a dominant role in explaining
causes of variance in the Thai stock market’s monthly returns. Therefore, one may infer to a
large degree that the Thai stock market is greatly influenced by the success of the stock
markets of its neighbouring counties, but non – regional markets have had an insignificant
impact.

Other study from Murat Doganlar (2002), implementation of the Engle – Granger
method suggests that there is a long – term equilibrium relationship between real exports, real
foreign demand, relative price and volatility of exchange rate, because test statistics except
for Indonesia are above the 5 % critical value. The co – integrating relation is a 10 % critical
level appropriate for Indonesia. These finding indicate that there is a temporary deviation
from the relationship. The words suggest the signs are as planned, the term of international
activity is strongly linked to actual exports, and this term has a significant influence on these
countries’ exports. The international operation expression coefficient is between (2.06) and
(3.86). The relative price term, that is to say the term price elasticity, has negative sign as
predicted. The relative term for prices varies from (70.46) to (71.52). The currency volatility
term measure for all countries is also negative and ranges from (70.65) to (72.24). The
negative sign for the volatility term suggests that if exchange rate volatility (uncertainty)
increases, risk – averse producers would avoid domestic trade in avoid of foreign commerce.
A significant finding is that the long – term coefficient of exchange rate volatility term for
Turkey, South Korea, Malaysia and Indonesia is higher than the relative price – term
coefficient, which mean export volatility is more powerful than the relative price – period, the
finding also show South Korean exporters are among the most vulnerable to exchange rate
fluctuations. The error correction term coefficient indicates that the adjustment pace for
Indonesia, South Korea, Pakistan and Turkey is small. These findings indicates that adjusting
real exports to any adjustment in the regresses will take a long time to return to balance. This
means market forces rapidly restore equilibrium in the export market. The change pace in
Malaysia is however higher than in the other countries, for Indonesia and Malaysia a
significant coefficient could not be found for the foreign demand term. Nevertheless, the
international market concept greatly affects actual exports for other national. The effect of the
international demand term for these countries is greater than relative market term.

The key finding is that the volatility – time coefficient is significantly negative for
each region. This indicates that the volatility of exchange rate does not only have long – term
effects on real exports but also has short – term effect. Hence, it can be argued that if
volatility (instability) rises in exchange rates, risk – averse producers will prefer domestic
trade over foreign trade and thus exports will be negatively affected by exchange rate
instability. This paper analysed the effect of the volatility of exchange rates on exports from
five Asian countries: Turkey, South Korea, Malaysia, Indonesia and Pakistan. The effect of
exchange rate fluctuations on export is investigated using residual co integrating technique
from Engle – Granger. The term volatility o defined as the moving standard deviation of real
exchange – rate growth. The result show that there is a long – term balance between real
exports, international investment, relative prices and volatility of the exchange rates. The
instability of exchange rates has been found to have limited real exports for these countries.
This indicates that the producers are usually risk – averse in these countries. In other words,
increased currency volatility would increase confusion about the potential behaviour of the
exchange rates. Exporters would therefore tend to sell in domestic markets rather than foreign
markets, so they will be negatively affected by exports.
 Study by Olugbenga Onafowora (2003), for the economic review, the
researcher use quarterly data from the IMF, International Financial Statistics, 2002 CD-ROM
and IMF, Trade Statistics Quarterly, covering period 1980: 1 to 2011: 4. The real bilateral
exchange rate against the US dollar is determined by multiplying the nominal exchange rate
by the US wholesale price index ratio to the domestic price level. After determining the
Yen’s domestic currency value from the domestic currency exchange rate ratio against the
US dollar to the Yen rate against the US dollar, a similar process is followed to produce the
real rate against the Japanese Yen, the actual international revenue is imputed by the actual
GDP of Japan or the US quarterly. For the exception of Malaysia, where we use the industrial
output index, the quarterly real GDP has been used as reference for the real domestic income
for the all other countries. Due to the lack of quarterly GDP data covering the entire sample
span, industrial output was used to reflect real income in Malaysia. Since there is one co -
integrating vector connecting the variables, it is possible to obtain an economic interpretation
of the results by normalizing the co – integrating vector at in (X/M). The researcher was
reported the co – integrating coefficients, using the Johansen method.

In all cases, the findings suggest a positive long – term relationship between real
exchange rate and real balance of trade, as would be expected if a real depreciation resulted
in more exports and less imports. The results for Indonesia – Japan, Indonesia – US and
Malaysia – US indicate that real balance of trade has a long – term negative relationship with
real domestic income and positive long – term relationship with real foreign income. Those
signs are what we would expect if demand were the guiding force in export and import
determination. The actual trade balance in the models for Thailand Japan, Thailand – US and
Malaysia – Japan has a positive long – term relationship with actual domestic income and a
negative long – term relationship with real foreign income. These indicators are what we
would expect if an increase in real income were the driving force in deciding export and
imports due to increased productivity or output of import substitute goods. Finally, in all the
calculations, a statistically significant coefficient is found for the dummy change variable.
 This indicates that the Asian financial crisis of 1997 and the crisis – driven reforms
greatly impacted the relationship between actual balance of trade. However, the fact that we
find evidence of co – integration in all of the models leads us to believe that these episodes do
not threaten the long – term stability of the actual trade balance equation. Regarding
Indonesia, the J – curve effect is observed in its bilateral trade with Japan and the US, after a
real depreciation, Indonesia is showing an initial short – run deterioration in the real trade
balance, accompanied by a long – run improvement. With a one standard deviation shock in
real exchange rate, the initial declined in the actual trade balance is more than 1 %, the
degradation continues for about third quarterly, after which the effects of volume are set in,
when the trade balance gradually settles down to a new long – term equilibrium point that is
higher than initial value, a cyclic trend emerges. A significant decline in Malaysia’s real
bilateral trade balance with japan and the US following a single standard deviation from the
real exchange rate. This was followed by trade balance change and then deterioration. As
with Indonesia, a cyclical trend emerges as the trade balance settles down to a new level of
long – run equilibrium that is only marginally higher than the initial value.

The initial negative effect of a real depreciation on Malaysia’s balance of trade with
Japan and the United States supports the J – curve hypothesis. The goal of this paper was to
analyse the short – term and long – term effects of real exchange rate adjustments on the real
trade balance for three ASEAN countries Thailand, Malaysia and Indonesia in their bilateral
trade with both the United States and Japan, and to decide whether the Marshall – Lerner
conditions hold. Using a frameworks for vector correction of co – integration errors that
treats all variable in the model as potentially endogenous, we estimated generalized impulse
response functions to maps the possible effect of real bilateral exchange rate shocks on the
bilateral trade ratio. In all situations, the co – integration study showed that real trade balance
real exchange, real domestic income, and real foreign income have a long – term steady state
relationship. CUSUMSQ parameter stability testes have confirmed that the models are fairly
stable over the analysis period. Our results indicate that there are short – term J – curve
implications for Indonesia and Malaysia in their bilateral trade to both the US and Japan and
for Thailand in its bilateral trades to the US. There is an initial deterioration in the trade
balance with a real depreciation which lasts around fourth quarters but this is followed by a
long – term improvement. In its bilateral trade with Japan, Thailand has the opposite
movement: a real shock of devaluation of the exchange rate initially strengthened, then
weakened and then strengthened the trade balance. This pattern does not support the
traditional J – curve hypothesis, but supports the S – curve trend.

Research by Appolo and Zulkifli (2019), Indonesia and Malaysia have no difference
in market return. Both countries do have ties, however, the result of the research conform to
Hamid et.al. (2010), which reported that the capital market in Malaysia was inefficient in
poor for, meaning that the capital markets in Indonesia and Malaysia did not differ. The
research findings show that both countries have long- term constructive relationship with the
Malaysia capital market, Arsyad (2015). Santosa (2013), which has stated a positive
correlation between JCI and FTSE Malaysia (KLSE) also supports the results. According to
research findings, the market return on Indonesia stock markets have no difference from
Singapore, Vietnam, Thailand, Malaysia and The Philippines, which are aligned with the
signalling theory. For three countries in Southeast Asia, empirical evidence is given that the
knowledge content on the stock exchange of these countries will be responded in the same
direction by investors and market players on the Indonesian Stock Exchange, as it has a
significant relationship.

Thailand, Malaysia and the Philippines serve as the signalling senders of stock
movement and the receiver functions as the Indonesian Stock Exchange. Investors or market
participants view the knowledge signal as an investment activity in order to assess purchasing
or selling decisions. The researcher found information asymmetries in the form of
information imbalances kept by the management and shareholders of the company and
knowledge gaps between one investor and the other investor in each country. The effect will
result in a divergence in which there will be trend discrepancies with cross – directional
movements, positive and negative. There are also requirement for decisions to be made on the
basis of poor information (adverse selection), so investors need to react carefully to the
investment in seeking market information and then carry out analysis to get the right
investment decision