Review of Financial Economics 11 (2002) 299 – 315

Long-term trends and cycles in ASEAN stock markets

Subhash C. Sharma*, Praphan Wongbangpo
Department of Economics, Southern Illinois University Carbondale, Carbondale, IL 62901-4515, USA

Received 15 March 2001; received in revised form 12 October 2001; accepted 11 June 2002

Abstract

The objective of this study is to analyze the degree of long-term and short-term co-movements in
the stock markets of five ASEAN countries and to shed some light on the long-term and short-term
market efficiency/inefficiency in the region. We observe a long-run relationship among the stock
markets of Indonesia, Malaysia, Singapore, and Thailand, but the Philippine market does not share this
relationship. Thus, four cointegrated markets reveal long-term market inefficiency in the region but the
Philippine market can be considered efficient. Next, given that the four indices are cointegrated, the
number of common cycles are investigated in these markets and each stock index series is decomposed
into its trend and cyclical components. The trend – cycle decomposition reveals that in the short-run
four ASEAN markets can be categorized into two efficient groups, i.e., Malaysian and Singaporean
markets in one group and Indonesian and Thai markets in the other. However, the markets within each
group are inefficient.
D 2002 Elsevier Science Inc. All rights reserved.

Keywords: Asian stock markets; Indonesia; Malaysia; Philippines; Singapore; Thailand; Cointegration

1. Introduction

During the last two decades, there has been an increase in the interdependence and
integration of financial markets regionally and globally. The main reasons for this increased
integration are: first, the shift to floating exchange rates, market deregulations, and
liberalization, which in turn led to an increase in flow of capital across countries contributed

* Corresponding author. Tel.: +1-618-453-5070; fax: +1-618-453-2717.

E-mail address: sharma@siu.edu (S.C. Sharma).

1058-3300/02/$ – see front matter D 2002 Elsevier Science Inc. All rights reserved.
PII: S 1 0 5 8 - 3 3 0 0 ( 0 2 ) 0 0 0 6 2 - 9
300 S.C. Sharma, P. Wongbangpo / Review of Financial Economics 11 (2002) 299–315

to the globalization and to the integration process. Second, technological advances in

communications and trading systems have made financial transactions easily accessible to
investors across the world. The integration of financial markets has important regional and
global implications. If the markets are highly integrated, then a country’s economy can not be
insulated from foreign shocks and this reduces the scope for independent monetary policy.
Moreover, effective diversification among international markets can not be achieved and the
integrated markets can be considered as one market set by long-term investors. On the other
hand, if the financial markets are not interrelated, this serves as a good avenue for portfolio
diversification.
Thus, growing interest in globalization of financial markets has drawn the increased
attention of researchers to empirically investigate the interdependence in the short-run and
long-run, and to quantify the integration of regional and world-wide financial markets.
Between the New York and Japanese stock markets, Lai, Lai, and Fang (1993) observed both
the short-run and the long-run feedback relationships. For the G-7 countries, there are mixed
findings. Kasa (1992) observed a single common trend, but Choudhry (1994) did not support
a common stochastic trend in these markets. Among the major European markets, Choudhry
(1996), Koutmos (1996), and Serletis and King (1997) all observed long-run relationships.
Gallagher (1995) supported Choudhry’s claim and noted that the long-run relationship among
Irish, British, and German markets do not exist in either the stock price level or the stock
returns. For the Scandinavian markets, Booth, Martikainen, and Tse (1997) noted that these
markets are weakly related to each other.
There have been some investigations for the Asian and Pacific markets. Engle and Susmel
(1993), by using an autoregressive conditional heteroscedasticity (ARCH) model, observed
two closed-boundary groups among 18 nations that share similar volatility characteristics.
Mashi and Mashi (1997) studied four Asian newly industrializing countries (NICs) (Taiwan,
South Korea, Singapore, and Hong Kong), and investigated how the well-established markets
of Japan, USA, UK, and Germany propagate these markets. Their results revealed that
regardless of which established market is being considered, these markets drive the
fluctuations in NICs’ markets. Furthermore, Hung and Cheung (1995) find a long-run
relationship among five Asian emerging stock markets (ESMs): Hong Kong, Korea,
Malaysia, Singapore, and Thailand. However, Kwan, Sim, and Cotsomitis (1995) observed
that four Asian ESMs, i.e., Hong Kong, Singapore, Korea, and Taiwan, are not cointegrated
among themselves but they are cointegrated with G7 countries. On the other hand, Chan,
Gup, and Pan (1992) and Chan, Gup, and Pan (1997), in a bivariate cointegration analysis,
found support for the international diversification in five major Asian markets and in
European Union (EU) markets. Furthermore, Corhay, Rad, and Urbain (1995) addressed
the significance of the regional aspects of the common stochastic trend in the stock markets
among Pacific-Basin countries. They find that, in the long-run, there exists a geographical
separation between the Asian and the Pacific markets. However, for the Southeast Asian, or
ASEAN countries, Palac-McMiken (1997) (using the bivariate Engle and Granger cointegra-
tion analysis) concluded that all the markets are linked together with the exception of
Indonesia. Furthermore, based on the weekly data for the period 1988 – 1995, Roca,
Selvanathan, and Shepherd (1998) examined the linkage in the markets of these five countries
 S.C. Sharma, P. Wongbangpo / Review of Financial Economics 11 (2002) 299–315 301

and concluded that these markets are related in the short-term, but not significantly linked in
the long-run.
A detailed investigation of the ASEAN stock markets is of interest because of the
increased economic cooperation in accordance with the ASEAN agreement, the successful
financial reform, and the distinguished structure of emerging stock markets. Hence, the
purpose of this study is to investigate the short-run and long-run co-movements in the
ASEAN stock markets and provide explanations for these market movements. Note that some
shocks are short-lived or transitory and only affect stock prices for a short period of time. On
the other hand, other shocks are persistent (stay for a long time) and affect stock prices for a
long period of time. We call these shocks the semipermanent.1 The stock indices of two or
more countries may respond to a transitory shock by moving together for a short period of
time. However, the same indices may respond to persistent shocks by slowly adjusting to
these shocks for a long period of time. In the literature (see Engle & Issler, 1993; Engle &
Kozicki, 1993; Vahid & Engle, 1993), these short-run co-movements are called common
cycles (serial correlation common feature) and long-run co-movements are called common
trends. Thus, the objectives of this study are as follows. First, we investigate whether there
exists a long-term relationship among the stock price indices among Indonesia, Malaysia, the
Philippines, Singapore, and Thailand. This will reveal the long-term efficiency/inefficiency of
these markets. Second, given that these stock price indices are cointegrated, we investigate
the number of common cycles in these markets. Finally, to shed some light on the short-run
efficiency/inefficiency of these markets, the stock indices of each country are decomposed
into trend and cycle. Monthly data from January 1986 to December 1996 is used in this study.
The paper is organized as follows. In Section 2, we briefly discuss the characteristics of
ASEAN stock markets. An outline of methodology is given in Section 3 and details of data
are discussed in Section 4. Section 5 contains the model specification and cointegration
analysis. The trend and cycle decomposition analysis is presented in Section 6. Finally,
Section 7 concludes this study with some remarks and policy implications.

2. ASEAN market characteristics

During the last two decades, the rapid economic growth in the ASEAN countries was
accompanied by an incredible increase in the size of their stock markets. Over the 7-year
period (1990–1996), the market capitalization of Indonesia, Malaysia, Philippines, Sin-
gapore, and Thailand grew 816.38%, 360.20%, 637.66%, 83.69%, and 211.81%, respectively
(World Stock Exchange Fact Book, 1997). The increase in market capitalization is attributed
to both price appreciation of listed firms and to an increase in the number of listed firms. This
immense growth in market capitalization can be characterized as the emerging market
phenomenon. However, the ASEAN stock market crash in July 1997 brought all markets in

1
We are reluctant to call these persistent shocks the permanent shocks. For lack of appropriate terminology,
we call these the semipermanent.
302 S.C. Sharma, P. Wongbangpo / Review of Financial Economics 11 (2002) 299–315

this region into a collective financial crisis. This contagion effect suggests that stock markets
in the ASEAN countries are closely linked.
The globalization of the capital forming process yielded a unique challenge to the ASEAN
markets. In the early 1980s, when these markets took off, funds from depressed European
countries and recession-bound Japan were directed to these markets for the high profit
margin. During the period of 1988–1991 and 1993–1996, the total foreign investment inflow
into five ASEAN countries, Indonesia, Malaysia, the Philippines, Thailand, and Korea
skyrocketed up to almost US$70 billion (Biers, 1998, pp. 9 and 11). This high inflow of
foreign investment, as well as financial liberalization and deregulation undertaken domest-
ically, had created a boom in ASEAN capital markets.
Price (1994, p. 14) provides the risk ratings from the international country risk guide
(ICRG) of these markets. The ranking takes into account political, financial, and economic
issues. At the end of 1992, the Philippine stock market was considered the least attractive
with respect to the aforementioned considerations, followed by the Indonesian and Thai
markets. Palac-McMiken (1997) also derives ASEAN stock market risks and returns from the
investment return and market volatility. He pointed out that the Indonesian stock market bears
the highest risk and return. The returns from both the Philippine and Thai stock markets are
roughly at the same level but the Thai market carries much less risk, making it comparatively
more attractive to investors. The low risk in the more advanced markets of Malaysia and
Singapore is accompanied by low return. In this study, the rank for risk and return across
ASEAN stock markets calibrated by Palac-McMiken will be referred to as the characteristics
of these markets.

3. Methodology

First, by using the augmented Dickey-Fuller (ADF) and Phillips and Perron (PP) tests
(Perron, 1988; Phillips & Perron, 1988), each series is tested for unit roots. Next, to test for
the number of cointegrating vectors (CVs), i.e., the long-run relationship among the ASEAN
markets, the maximum likelihood based 8-max and 8-trace statistics introduced by Johansen
(1988, 1991) are used. Since the methodologies of testing unit roots and number of CVs is
well known, the details are omitted here.
However, the serial correlation common feature, i.e., common cycles methodology is fairly
new, its general discussion is briefly reported. For mathematical details, readers are directed
to the original sources Engle and Issler (1993), Engle and Kozicki (1993), and Vahid and
Engle (1993). It is well known that an indicator of co-movement among nonstationary
variables is cointegration. When the variables are cointegrated, they share common stochastic
trends and at least one linear combination of them is stationary. On the other hand, an
indicator of co-movement among stationary series is codependence. Engle and Kozicki
defined the strong form of codependence as the serial correlation common feature and
proposed test statistics to test for the serial correlation common feature for stationary series.
Vahid and Engle pointed out that the existence of a serial correlation common feature among
the first difference of a set of I(1) variables implies the existence of a common cycle.
 S.C. Sharma, P. Wongbangpo / Review of Financial Economics 11 (2002) 299–315 303

Note that, in an (n
1) vector, xt, of I(1) variables, Johansen (1988, 1991, 1992) showed
that there can exist r( < n), linearly independent CVs and the collection of these vectors
form the n
r matrix B, where b0xt is I(0), and the subspace of all possible CVs is called
the cointegration space. Vahid and Engle (1993, p. 342, Definition 2) specifies that,
‘‘Elements of Dxt have a serial correlation common feature if there exists a linear
combination of them, which is an innovation with respect to all observed information
prior to t. Such a linear combination is called a cofeature combination and the vector which
represents it is called a cofeature vector.’’ There can exist s( < n) linearly independent
cofeature vectors and the collection of all linearly independent cofeature vectors form the
n
s matrix B ~ where ~bDxt is an innovation. The subspace defined by the range of matrix
B is called the cofeature space. Vahid and Engle (1993, p. 345) showed that, if there
~
exists r linearly independent CVs (r < n) among the xt variables, then if elements of xt
have common cycles there can, at most, exist (n  r) linearly independent cofeature
vectors that eliminate the common cycles.
Further, Vahid and Engle (1993) provided statistics to test for common cycles when the series
are cointegrated and also a procedure to estimate the number of common cycles. Vahid and
Engle and Engle and Issler (1993) showed that a test for common cycles is in fact a test for the
significance of canonical correlations between Dxt and (b0xt  1, Dxt  1, Dxt  2, . . ., Dxt  m + 1).
The test statistic proposed by Vahid and Engle is for the null hypothesis that the dimension of
the cofeature space is at least s (or equivalently there are at most (n  s) common cycles) and is
given by:

X
s
Cðm*; sÞ ¼ ðT  m*  1Þ lnð1  l2 Þ ð1Þ
i¼1

where the li2 are the s smallest squared canonical correlations between Dxt and (b0xt  1,
Dxt  1, Dxt  2, . . ., Dxt  m + 1), T is the number of observations, m* is the lag length of VAR
system in difference, i.e., m  1, and r represents the number of CVs. C(m*,s) is asymptot-
ically distributed as chi-square with (nm* s + rs  ns + s2) degrees of freedom.
Finally, Vahid and Engle (1993) also showed that in a special case when there exist r
linearly independent CVs and (n  r) linearly independent cofeature  ~0  vectors, the trend and
b
cycle part of each series can be recovered. Let a matrix B ¼ , where B is a (r
n)
b0
~
matrix of CV and B~ is a (s
n) matrix of a cofeature vector. B is of full rank since B and B are
linearly independent, n = r + s, and thus B will have an inverse. Partitioning the columns of
B  1 accordingly, i.e., B  1 =[b ~  | b  ], we can recover the trend cycle decomposition as
follows:

xt ¼ B1 Bxt ¼ be be0 xt þ b b0 xt ¼ Trend þ Cycle ð2Þ

Eq. (2) is clearly a trend–cycle decomposition. The first term contains only the trend
because be0xt is a random walk and hence cycle free, and the second term characterizes cycle
since b0xt is I(0) and serially correlated.
304 S.C. Sharma, P. Wongbangpo / Review of Financial Economics 11 (2002) 299–315

4. Data

The end-of-month closing share price indices from January 1986 to December 1996,
obtained from DataStream (Thailand), are used in this study. The indices used are: for
Indonesia, the Jakarta stock exchange composite stock price index (JCSPI); for Malaysia, the
Kuala Lumpur stock exchange composite index (KLSE); for the Philippines, the Philippine
stock exchange composite index (PSE); for Singapore, the stock exchange index of Singapore
(SES); and for Thailand, the stock exchange index of Thailand (SET). Note that JCSPI, SES,
and SET are indices of all stocks listed on these markets, while the KLSE lists 100 stocks
from nine main business sectors, and the PSE consists of 30 stocks, representing four main
business sectors.2 The starting date is appropriately chosen to correspond to stock market
transactions when the ASEAN markets emerged from the era of financial regulation. The
ending date of December 1996 is chosen to exclude the excessively volatile period during and
after 1997 in the ASEAN markets, a period also marked by increased government
interventions. During the time span used in this study, some noticeable political and
economical events may have affected the share indices. The 1987 crash of US markets is
one such event. However, this event does not warrant the analysis to be done for the pre and
post 1987 periods.3,4

5. Model specification and long-run relationship

5.1. Model specification

Let xt be a (5
1) vector, xt=(SIIt, SIMt, SIPt, SISt, SITt)0, where SIIt, SIMt, SIPt, SISt, and
SITt are the stock indices at time t for Indonesia, Malaysia, Philippines, Singapore, and
Thailand, respectively. Prior to the empirical analysis, all the series are transformed into
natural logs and their integrated properties are investigated. The ADF and PP unit root tests
indicate that we fail to reject the null hypothesis of unit roots in stock indices of all countries.
However, both ADF and PP tests reject the null hypothesis of a unit root in log first difference
of these series. Thus, we observe that each stock index series appears integrated of order 1, or
I(1). To save space, the unit root test statistics in Table 1 are reported only for log first
differences.

2
As of December 1995: World Stock Exchange Fact Book (1997).
3
One reviewer suggested that we exclude 1987 from the analysis or break the period into shorter intervals to
avoid any potential impact of the stock market crash in the USA on our findings. We respectfully disagree for two
main reasons. First, the plots of ASEAN stock indices in Fig. 3 do not suggest any detectable pattern that might
affect our conclusions regarding long-term trends and cycles. Second, dividing the series into shorter periods is
likely to obscure long-term trends and cycles that we find to exist in the series.
4
It is also worth noting that a number of researchers (e.g., see Choudhry, 1994; Corhay et al., 1995; Engle &
Susmel, 1993; Kasa, 1992; Koutmos, 1996; Kwan et al., 1995; Lai et al., 1993; Palac-McMiken, 1997; Serletis &
King, 1997 among others) who have analyzed time series of stock indices of many countries and covered
comparable periods do not consider the inclusion of 1987 as a source of concern.
 S.C. Sharma, P. Wongbangpo / Review of Financial Economics 11 (2002) 299–315 305

Table 1
Unit root test statistics for ASEAN stock price indices
LAG ADF test PP test
Model 1 Model 2 Model 1 Model 2
ta * ta  Z(ta * ) Z(a* ) Z(F1) Z(ta  ) Z(a  ) Z(F2) Z(F3)
LOG 1st difference
INDO 0  10.15*  10.16*  10.18*  119.30* 51.82*  10.18*  119.13* 34.50* 51.76*
MALA 2  11.60*  11.58*  11.60*  135.20* 67.37*  11.58*  134.73* 44.76* 67.14*
PHIL 0  9.79*  9.89*  9.76*  107.46* 50.31*  9.85*  107.98* 32.25* 48.37*
SING 2  10.52*  10.51*  10.50*  117.68* 55.20*  10.50*  117.48* 36.67* 55.01*
THAI 5  9.62*  9.93*  9.61*  109.11* 64.30*  9.88*  108.54* 32.44* 48.67*

Critical values for T = 100

95%  2.89  3.45  2.89  13.70 4.71  3.45  20.70 4.88 6.49
99%  3.51  4.04  3.51  19.80 6.70  4.04  27.40 6.50 8.73
Model 1: model with nonzero mean. Model 2: model with nonzero mean and linear trend.
The optimal lag length for each of the autoregressive process of ADF test is settled by Akaike Information
Criterion (AIC). The lag lengths used in the PP tests are determined by Schwert (1987) formula: l132 = Int{4(T/
100)0.25} to be four. The adjusted Z test statistics are given in detail in Perron (1988, pp. 308 – 309).
* Indicates the rejection of the corresponding null hypothesis at the 5% significance level.

5.2. Long-run relationship

Next, the various likelihood ratio (LR) tests are performed to determine lag lengths in the
VAR model. We begin with 24 lags. The general-to-specific procedure yields a VAR model of
nine lags. The chi-square statistics reveals no significant autocorrelation in the residuals.5
Johansen (1992) suggests a systematic test procedure for the cointegration model specifica-
tion by jointly testing both the rank order and the deterministic component.6 As indicated in
Table 2, at the 5% significance level, the l-trace statistics confirm a model with an intercept
term and one CV.
Tests for the properties of individual series, reported in Table 2, suggest that the Philippines
can be omitted from the cointegration relation. This statistical exclusion is consistent with the
characteristics of the Philippines market due to the following reasons. Economically, the
Philippines market possesses the smallest degree of trading relation with other ASEAN-5
countries.7 The capitalization of the Philippine market is considered the smallest relative to
other ASEAN’s. A group of Philippine stocks comprising approximately 87% of the market
capitalization dominates and tends to dictate the movement of market indices. Foreign investors
find the Philippine stock market rather restricted, since they are allowed to trade exclusively in

5
The null hypothesis of the existence of joint autocorrelation among the residual is rejected at the P value of
.8716.
6
See Harris (1995, p. 97) for the test procedure.
7
From 1993 to 1996, the Philippines has the smallest share, 5 – 6% in import and 2 – 4% in export, of the total
trade in the intra-ASEAN parameters (http://www.asean.or.id, as of June 4, 1999).
306 S.C. Sharma, P. Wongbangpo / Review of Financial Economics 11 (2002) 299–315

Table 2
Tests for model specification
Test for the constant term
Null Eigenvalues l-trace test 95% quantiles CV
Model 1 Model 2 Model 3 Model 1 Model 2 Model 3 Model 1 Model 2 Model 3
r=0 0.2511 0.2492 0.2570 87.17* 78.46* 98.66* 76.07 68.52 87.31
r=1 0.1420 0.1415 0.1710 51.60 43.20 63.02 53.12 47.21 62.99
r=2 0.1313 0.1197 0.1323 32.76 24.43 39.06 34.91 29.68 42.44
r=3 0.0815 0.0643 0.1079 15.46 8.74 21.60 19.96 15.41 25.32
r=4 0.0398 0.0046 0.0596 4.99 0.56 7.56 9.24 3.76 12.25
Model 1: model with a constant restricted to the cointegrating space.
Model 2: model with unrestricted constant.
Model 3: model with a linear trend in the cointegration vectors.

Test for the properties of individual series

Exclusion c2(1) Stationarity c2(4) Weak exogeneity c2(1)
INDO 4.46* 27.91* 7.25*
MALA 8.27* 27.45* 0.10
PHIL 0.00 27.58* 0.44
SING 7.46* 27.20* 1.14
THAI 7.63* 27.69* 0.84
95% quantiles 3.84 11.07 3.84

Tests for the number of cointegrating vectors

Eigenvalues Null l-max l-trace 95% quantiles CV
l-max l-trace
0.2511 r=0 35.57* 87.17* 34.40 76.07
0.1420 r=1 18.84 51.60 28.14 53.12
0.1313 r=2 17.31 32.76 22.00 34.91
0.0815 r=3 10.46 15.46 15.67 19.96
0.0398 r=4 4.99 4.99 9.24 9.24
Critical values are obtained from Osterwald-Lenum (1992).
* Indicates rejection of the null hypothesis at 5% significance level.

certain classes of stocks (Price, 1994, pp. 18–19). At of the end of 1992, only 10 out of 170
listed stocks were considered attractive to foreign investors (Price, 1994, p. 293).
Thus, the Philippine market is excluded from the CV and the restricted model of ASEAN-
4, i.e., xt=[Indonesia, Malaysia, Singapore, Thailand]0, is estimated. Table 3 reveals that both
the l-max and l-trace statistics fail to reject the null hypothesis of a single CV at the 5% level
of significance. The Ljung–Box and Lagrange Multiplier statistics indicate that the residuals
are not serially autocorrelated.8 Thus, we conclude that, in the long-run, there exists a
stationary linear combination of ASEAN-4 stock price indices.
8
The white noise criteria are determined by the Ljung – Box, or L-B (30), and Lagrange Multiplier, or LM(1)
and LM(4), statistics. The null hypothesis of no autocorrelation among the residuals is rejected by the P value of
.13, .35, and .35, respectively.
 S.C. Sharma, P. Wongbangpo / Review of Financial Economics 11 (2002) 299–315 307

Table 3
Tests for number of cointegrating vectors in restricted model
Eigenvalues Null l-max l-trace 95% quantiles CV
l-max l-trace
0.2350 r=0 32.94* 63.52* 28.14 53.12
0.1134 r=1 14.81 30.58 22.00 34.91
0.0879 r=2 11.31 15.77 15.67 19.96
0.0356 r=3 4.46 4.46 9.24 9.24
Lag length of 9 and a constant deterministic term are incorporated into the model. CV: Critical values are obtained
from Osterwald-Lenum (1992).
* Indicates rejection of the null hypothesis at 5% significance level.

5.3. Testing restrictions in the CV

To obtain a unique and economically meaningful long-run relation, we proceed by

imposing and testing restrictions on the CV. A robust relationship between the markets of
Malaysia and Singapore is hypothesized due to the fact that their economies are closely
linked. The distribution of inward foreign direct investment (FDI) flow, the strength of
trade between these two economies (Tongzon, 1998, pp. 28 and 49), the geographical
proximity, and the cultural factors all indicate a strong relationship between these two
markets. In fact, both of these markets developed closely from the same root as the stock
exchange of Malaysia and Singapore, and became independent entities in 1973. Despite the
market separation, at the end of 1994, more than 110 Malaysian stocks as well as a few
other foreign issues were actively traded, accounting for more than 50% of the total market
capitalization in Singapore (World Stock Exchange Fact Book, 1997). Thus, we hypothes-
ize that in the CV there is proportionality between stock markets of Malaysia and
Singapore, i.e., their CV coefficients are equal but with opposite sign. The LR statistics
for this hypothesis is reported as R1 in Table 4. The test statistics reveal that the hypothesis
cannot be rejected.
Besides their strong relationship, the stock markets of Singapore and Malaysia are by far
the best equipped in Asia, except Japan and Hong Kong, to absorb foreign investment.
Malaysia and Singapore have received approximately two-third of the FDI flows in the

Table 4
The likelihood ratio test statistics
Hypothesis LR statistics P value
R1: b = H2 j 0.49 .48
R2: b=(H2j,y1) 0.15 .70
R3: b=(H2j,y2) 1.22 .27
R4: b=(H2j,y3) 3.15 .21
R1 tests that the coefficients of Malaysia and Singapore in the restricted cointegrating vector are equal. R2, R3,
and R4 test the exogenity of Malaysia, Singapore, and both Malaysia and Singapore, respectively.
308 S.C. Sharma, P. Wongbangpo / Review of Financial Economics 11 (2002) 299–315

ASEAN region (Tongzon, 1998, p. 146). Moreover, the capitalization in both markets
accounts for roughly 75% of the total stock market capitalization in this region. The fact
that stock markets of Malaysia and Singapore are highly developed relative to other
ASEAN markets justifies the notion that these variables are weakly exogenous to the
system and can enter the right hand side of the vector error correction model (VECM). The
LR tests of joint hypotheses, R2, R3, and R4 in Table 4, strongly indicate that Malaysia and
Singapore should be considered exogenous to the system. This possibly implies that the
path of co-movement among ASEAN stock markets is led by Malaysia and Singapore and
that the stock markets of Indonesia and Thailand proceed to adjust all the disequilibrium in
the long-run.

6. Trend and cycle decomposition

Next, given that four ASEAN stock indices are cointegrated, we test for the number of
common cycles in these indices. Toward this goal, test statistics given in Eq. (1) are computed
and reported in Table 5. We note that the null hypothesis that the cofeature space has a
dimension of four is rejected. This suggests that the system of four ASEAN stock indices
possess one common cycle and three cofeature vectors. Thus, in this case, the sum of the
number of cofeature and CVs is equal to the number of variables in the system. Finally, using
Eq. (2), we recover the permanent (trend) and transitory (cyclical) components of each stock
index, and these are plotted in Figs. 1 and 2.
Fig. 1 reveals that the trends in the Malaysian and Singaporean markets are quite
comparable. They project identical patterns and directions toward the future regardless of
market bullishness, or bearishness. Meanwhile, Thailand’s market shared the same trend as
those of Malaysian and Singaporean markets until early 1991, when foreign investors lost
confidence in Thai market due to the military coup in February 1991. This resulted in a huge
loss in Thai stock market performance. Since foreign investors observed no fundamental
change in political direction after the military disturbance, the Thai market has become
relatively stagnant in the international portfolios since 1992 (Agtmael, 1993, p. 125),
reflecting the steady trend in Thai stock market. For the Indonesian market, the trend moved
close to its peak in late 1988, and fluctuated there till mid-1990. Following Price (1994, pp.
265–266), this incident could be explained by a series of deregulation packages, reforms, and

Table 5
Test for serial correlation common feature
H0 r2i C(m*,s) df P value
s=1 0.1374 18.1831 30 .9555
s=2 0.1679 40.7926 62 .9829
s=3 0.2609 77.9800 96 .9104
s=4 0.5517 176.6541 132 .0057
P values are based on the chi-square distribution, df are degrees of freedom, r2i are squared canonical correlations.
 S.C. Sharma, P. Wongbangpo / Review of Financial Economics 11 (2002) 299–315 309

Fig. 1. ASEAN stock markets: trend components.

policy adjustments issued during the period 1987–1988. The intention of the Indonesia’s
government was to spur development of its capital market. It succeeded for only a few years.
In mid-1990, Indonesia experienced a two and a half-year period of difficult times.
Bearishness reemerged in the market due to the fear of a tightened money supply,
disappointing corporate performances and other concerns of market regulations, i.e.,
inadequacy of supervision and a lack of reliable information about listed companies (Price,
1994, p. 266). To upgrade market professionalism, the Capital Market Supervisory Agency
was created as a supervisory body for the Indonesian stock market in 1991 (Price, 1994,
p. 267). Clearly, the market policy adjustment, as well as the influx of FDI in 1993, pushed
Indonesian market indices up drastically. One striking point here is that the permanent
components of the Indonesian and Thai stock markets did not register the similar leap, as did
the markets of Malaysia and Singapore. One possible explanation is that the permanent
components of Indonesia and Thailand are less sensitive to the aggressiveness of foreign
investors. The stock markets of Indonesia and Thailand still impose some restrictions,
despite the financial liberalization policy, toward foreign investment, i.e., foreign investors
in Indonesia and Thailand are required to ensure the repatriation rights before involving in
the markets (Park, 1993, p. 11; Price, 1994, pp. 18–19). Due to rather strict market
structure, the permanent components in Indonesia and Thailand are quite stable even though
the market indices are pushed upward by the inflow of FDI. With this regard, local policy
makers could help sustain the stock market performances by deregulating restrictions
regarding foreign investment.
310 S.C. Sharma, P. Wongbangpo / Review of Financial Economics 11 (2002) 299–315

Fig. 2. ASEAN stock markets: cycle components.

From Fig. 2, we observe that the cyclical components of Indonesia and Thailand are
positive and move together during the entire sample period. As a cyclical component is
derived from the actual series deviating from the trend, the stock market performances in
Indonesia and Thailand achieve higher market levels than do their long-term trends. On the
other hand, the cyclical components of Malaysia and Singapore are below zero, suggesting
that their stock market performances stay below their trends. Moreover, Indonesia, Thailand,
and Singapore follow the same cyclical pattern, even though they are inversely related, while
Malaysia has its own rather stable path over the entire sample period. The inverse relationship
between the cyclical components of Singapore and Indonesia/Thailand is quite interesting as
it emphasizes the significance of Singapore as the financial and investment center for the
ASEAN region. The significantly higher risk and return in Indonesian and Thai stock markets
relative to that of Singapore allow investors in Singapore to benefit from the risk premium in
the bullish markets of Indonesia and Thailand. At the same time, investors in Indonesian and
Thai stock markets could reduce their investment risk by including Singaporean securities in
their portfolio. Due to the higher risk and return in Indonesia, the cyclical components in
Indonesian market exhibit more volatility than in Thailand. The risk premium benefit has less
influence in the Malaysian stock market.
In Fig. 3, we plot the actual series relative to its own trend and cyclical components for
ASEAN-4 countries. Their characteristics are analyzed in order to shed some light on the nature
of each stock market. These stock markets can be classified as either trend-dominated or cycle-
 S.C. Sharma, P. Wongbangpo / Review of Financial Economics 11 (2002) 299–315 311

dominated markets. In cycle-dominated markets, such as in Indonesia and Thailand, the

transitory shocks play a major role in the deviation of actual series from their trends. The
permanent components from both Indonesia and Thailand are fairly stable and experience very
little growth. A higher return in the Indonesian and Thai stock markets attracts foreign
investment, including the portfolio investment from Malaysia and Singapore, and consequently
causes the market indices to outperform market trends. The increase in gap between the actual

Fig. 3. ASEAN stock markets: trend and cycle decomposition.

312 S.C. Sharma, P. Wongbangpo / Review of Financial Economics 11 (2002) 299–315

Fig. 3 (continued).

series and their trends started to take off when Indonesia and Thailand seriously implemented
financial liberalization policies in the mid-1980s. The actual-trend gap is even broader with the
influx of FDI in 1993. On the other hand, Malaysia and Singapore are categorized as trend-
dominated markets, due to their below-zero cyclical components. The actual stock indices in
these markets are underperforming relative to their long-term trends. This can be explained by
 S.C. Sharma, P. Wongbangpo / Review of Financial Economics 11 (2002) 299–315 313

the fact that the portfolio investment in these countries is probably directed to the Indonesian
and Thai markets for higher returns.

7. Conclusion and policy implications

By analyzing the long-term and short-term relationships among the five ASEAN stock
market indices, i.e., Indonesia, Malaysia, the Philippines, Singapore, and Thailand, this
study sheds some light on the market efficiency/inefficiency and portfolio diversification in
the region. We observe that the Philippines market does not share a long-run relationship
with the rest of the ASEAN markets considered here. However, the remaining ASEAN-4
markets share a long-run relationship. It can be interpreted that the Philippines market is
efficient in the region. The cointegrated remaining four stock markets reveal the evidence
of long-term market inefficiency in these stock markets, i.e., stock price movements in one
market can be predicted using the others’ stock prices. Moreover, as a domestic or
international investor tries to diversify his investment, an effective long-term portfolio
diversification among ASEAN-4 stock markets cannot be achieved. However, an investor
could include the Philippines stocks in his regional portfolio without compromising on the
concept of international diversification. Lastly, the comovement of ASEAN stock markets
in the long-run points to the limitation associated with the pursuit of interdependent policy,
especially the financial policy. Rather, as the ASEAN economies become more integrated
regionally, there is a need for policy coordination among the ASEAN to mitigate the impact
of financial fluctuations, as the stock markets are interdependent. This greater policy
coordination, along with the reduction or removal of trade and investment barriers, will be
essential if these countries are to exploit the advantages of greater economic and financial
interdependence.
We observe that the permanent and transitory components in the Malaysian and
Singaporean stock markets are similar in terms of patterns and directions, as they are
classified trend-dominated markets. On the other hand, stock markets of Indonesia and
Thailand are cycle-dominated. Thus, in the short-run, Malaysian and Singaporean markets’
stock movement can be predicted from each other’s, and the stock indexes of Indonesia and
Thailand can be predicted from each other. Thus, we conclude that, in the short-run,
Malaysia and Singapore markets are jointly inefficient; Indonesian and Thai markets are
jointly inefficient. However, in the short-run, these four countries can be classified into two
efficient groups, i.e., first group consists of Malaysia and Singapore and the second group
consists of Indonesia and Thailand. Note that the classification of trend and cycle
dominated markets in the ASEAN properly coincides with the level of stock market
development. The stock markets of Malaysia and Singapore are highly developed and
mature relative to those of Indonesia and Thailand.9 On the other hand, stock markets of
Indonesia and Thailand require certain development to enhance their market performances.

9
We reach this conclusion from the fact that the combined market capitalizations of Malaysian and
Singaporean stock markets comprise roughly 75% of the total capitalization in the ASEAN region.
314 S.C. Sharma, P. Wongbangpo / Review of Financial Economics 11 (2002) 299–315

Removing the foreign investment restrictions, as well as continuing to implement financial

liberalization, would serve as good avenues for market improvement.10

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