Institutional quality, macroeconomic factors and stock

market volatility: A cross-country analysis for pre, during

and post global financial crisis

Sarod Khandaker, Omar Al Farooque

The Journal of Developing Areas, Volume 55, Number 1, Winter 2021, (Article)

Published by Tennessee State University College of Business

DOI: https://doi.org/10.1353/jda.2021.0024

For additional information about this article

https://muse.jhu.edu/article/766456

[ Access provided at 21 Nov 2020 13:53 GMT from Carleton University Library ]
 The Journal of Developing Areas
Volume 55 No. 1 Winter 2021

INSTITUTIONAL QUALITY,
MACROECONOMIC FACTORS AND STOCK
MARKET VOLATILITY: A CROSS-COUNTRY
ANALYSIS FOR PRE, DURING AND POST
GLOBAL FINANCIAL CRISIS
Sarod Khandaker
Swinburne University of Technology, Australia
Omar Al Farooque
University of New England, Australia

ABSTRACT

This paper investigates how stock market volatility of Ten (10) developed and Seven (7) emerging
economies were affected by the institutional quality and macroeconomic factors using data from 2001
to 2012. Applying the standard historical volatility model adopted by Jones et al. (1998) and
Andersen and Bollerslev (1998) we find that stock market of the sample countries was volatile during
the Global Financial Crisis (GFC) and these effects were statistically significant for the sample
emerging countries as well as developed country groups. There is evidence that the sample emerging
stock markets exhibited higher stock return volatility than developed stock markets during the
observation period. We also find that stock return time-series variables were not stationary over the
study period at 1 per cent difference. The study uses the fixed-effects approach to determine the
institutional quality and macroeconomic factors that impacted higher stock market volatility for the
sample emerging and developed country group. Aligned with institutional theory, we also document
that several institutional quality country-level governance indicators and macroeconomic variables
are statistically correlated with the stock market volatility during the observation period. For
example, we find evidence that some institutional quality and macroeconomic indicators such as rule
of law, and credit information have a significantly negative effect on stock market volatility, while
other macroeconomic variables such as carbon dioxide (Co2) emission, tax revenue, and board
money have a significant positive association with stock market volatility. These findings suggest
that our sample markets were volatile not only because of the other macroeconomic factors but also
for institutional quality factors. The robustness test also produces similar results with little variation.
The findings of this investigation have several policy implications. First, there is evidence that stock
markets of the developed and emerging countries were volatile during the GFC and the rule of law
appears to be the dominant factor in deterring the stock market volatility. Further, several
macroeconomic and fiscal factors, including Co2 emission, tax revenue and board money may seem
to be a potential barrier for international investment and portfolio diversification. Therefore, an
international investor needs to be careful on portfolio diversification while investing in a poorly
structured economy.

JEL Classifications: G14, G15

Keywords: Volatility, GFC, Governance indicators.
Contact Author’s Email Address: skhandaker@swin.edu.au
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INTRODUCTION
This paper focuses on the volatility of stock market returns in developed and emerging
markets. In particular, it examines the effect of institutional quality with key country-level
governance indicators and a comprehensive set of macroeconomic factors on stock market
volatility in seventeen countries (i.e. ten developed and seven emerging economies) during
the period 2001 to 2012 (i.e. covering both pre and post-Global Financial Crisis (GFC).
Financial markets around the world severely suffer during the GFC. Although the GFC is
over in late 2010, the effects of GFC remain visible for a long time. During this period, the
European debt crisis contributes to substantial structural and economic changes in several
European economies. So, it is a matter of great interest to understand the macroeconomic
and institutional environment that influenced both emerging and developed countries
during the GFC and why the major world economies remained volatile even after the GFC.
A plethora of extant literature deals with the GFC and its effect on the financial markets in
the past, but no studies analyse the impact of institutional quality and macroeconomic
variables together on the stock market volatility in pre, during and post GFC. Prior studies
also document that emerging markets generally exhibit higher stock market volatility than
developed markets (Tobias and Rosenberg 2008; Ramchand and Susmel 1998; Mun and
Brooks 2012; Jayasuriya 2005). Hence, the focus of our study is to analyse the behaviour
of the selected sample stock markets during the GFC and how emerging markets performed
during the GFC as compared to the developed markets. More specifically, we are motivated
to determine the market-wide share price volatility during the GFC and analyse the
institutional quality and macroeconomic factors that influence the market volatility in
sample countries.
Therefore, the objectives of our study are twofold. First, we examine the stock
market volatility in pre, during and post GFC periods using stock markets of 17 emerging
and developed countries. Second, we determine the stock market volatility of the selected
stock markets using several country-level institutional quality and macroeconomic
variables simultaneously. In the literature, most of the studies link stock market volatility
with macro-economic factors (Cai et al., 2015; Gurlovelee and Bhatia 2015; Jia-Le et al.,
2015; Gatuhi et al., 2015). We complement the literature with our new paradigm focus not
only on a variety of macro-economic factors but also on institutional quality factors such
as rule of law, regulatory control, government effectiveness and corruption etc. These
institutional quality indicators have changed over the period both in developed and
emerging economies, however, there is a huge gap remains between the emerging and
developed countries in terms of enforceability and effectiveness of institutional quality
factors. Institutional weaknesses are very common in emerging markets as compared to
developed markets, which is not yet uncovered in determining their influence on stock
market volatility in both types of countries. Thus, our work contributes to a growing body
of literature shedding light on the importance of institutional quality and comprehensive
macroeconomic variables in financial markets considering the pre, during and post GFC
periods, as no studies focus on these determinants while explaining the stock market
volatility. Based on the standard historical volatility model adopted by Jones et al. (1998)
and Andersen and Bollerslev (1998b) and the institutional theory, our research intends to
expand the budding debate on institutional quality factors in determining stock market
volatility simultaneously with other traditional and non-traditional macro-economic
factors.
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The remainder of the study proceeds as follows. The next section includes a brief
literature review and the development of the hypotheses of our study. Section 3 outlines
the research methodology and data and section 4 demonstrates the analysis of the results.
In the last section, we provide a discussion and conclusion of the study.

THEORY, LITERATURE REVIEW AND HYPOTHESES DEVELOPMENT

Institutional theory is regarded as one of the most dominant theories in the governance
literature (Fiss, 2008). A central premise of institutional theory (DiMaggio and Powell,
1991; Scott 2004) suggests that institutional pressures are responsible for leading economic
activities and can be held accountable for influencing them (Greenwood & Hinings, 1993).
However, the notion that the pressures from institutional homogeneity brought to bear
similar influence throughout different organization and country was queried by many
(Kostova and Roth, 2002; Aguilera and Jackson 2003). Institutional theory has also focused
on explaining the stability and persistence of institutional change from an exogenous
perspective. Institutional theorists have argued that change occurs as a result of factors that
lie outside the control of the organization or country and individuals (Peters, 2000;
Campbell, 2004). The institutional theory should be able to provide a sensible explanation
that accounts for the national variation in response to global-exogenous processes and to
also explain why local responses to global pressures do not usually result in the
convergence of the same institutional model (Carney et al. 2009).
The stock market volatility literature is voluminous, ranging from the use of
volatility models to its determining factors. However, Figlewski (1997) suggests that the
simple historical volatility model generally predict future volatility better than the
complicated volatility models (e.g., GARCH). He argues that there is little gain using
higher frequency return data when forecasting volatility for longer horizons. Andersen and
Bollerslev (1998a) contend that Autoregressive Conditional Heteroscedasticity (ARCH)
and stochastic volatility models provide a good volatility forecast for market-wide
volatility. They argue that the standard historical volatility model is useful to predict stock
market volatility more accurately than other complicated volatility models. Bomfim (2003)
finds evidence that the US stock returns respond reliably to macroeconomic
announcements and government monetary policy. A recent study by Aizenman et al. (2016)
also finds evidence that the macro policy choice dictated by trilemma indices (i.e. exchange
rate stability, monetary policy independence and financial market openness) has a
significant effect on the changes in financial conditions or policies in the centre economies.
Several other recent academic literatures investigate the relationship between
stock market volatility and macroeconomic variables is a single country. For example, Cai
et al. (2015) investigate the forecasting power of macroeconomics variables on the Chinese
stock market volatility. They suggest several economic variables are strongly correlated
with the local market volatility and those variables can be used for monthly forecasting.
Consistent with the previous literature, the GARCH volatility shows a significant
predictive power for the realized volatility for the Chinese stock market. Gurlovelee and
Bhatia (2015) examine the impact of macroeconomic variables on the functioning of the
Indian stock market. They use monthly data for ten macroeconomic variables, including
broad money, call money rate, crude oil price, exchange rate, foreign exchange reserve,
foreign institutional investors, gross fiscal deficit, index of industrial production, inflation
rate and trade balance for their analysis, and BSE-500 as a branch mark index. They find
 360

no statistically significant relationship to BSE-500 with the macroeconomic variables

except for the exchange rate and foreign institutional investors’ index. Besides, financial
sector freedom is considered a tool for enhancing market openness. Bekaert et al (2006)
emphasize that market openness brings down volatility through enhancing risk
diversification process. Chinn and Ito (2006) argue that financial sector freedom has a high
positive effect when an economy maintains a high level of legal institutional quality. High
legal protection for investors and creditors results in a reduction in market volatility and
raises investors’ confidence in the economy (Silva 2002; Beck and Levine, 2004). Burda
and Wyplosz (2009) contend that the quality of institutions is considered a vital
element enforcing financial growth, thus robust institutional quality is essential for
emerging markets being driving force to raise financial development. Additionally,
Jia-Le et al. (2015) use 34 years’ time-series data from 1980 to 2013 for their analysis.
They use the FTSE Bursa Malaysia Index as the dependent variable and four independent
variables, including interest rate, exchange rate, consumer price index (CPI) and gross
domestic product (GDP) growth rate. They find evidence that interest rate is negatively
correlated with the Malaysian stock market and it has a significant impact on its capital
market. They also find that inflation rate, GDP growth rate is positively correlated with the
Malaysian stock market (Gatuhi et al. 2015).
Many studies in the literature show that market volatility is significantly affected
by weak institutions and that developing countries are always considered high volatile
markets. Mobarak (2005) contends that a strong relationship exists between market
stability and government institutions’ quality. Kaminsky et al. (2004) examines 104
emerging economies for the period between 1960 and 2003 and find that developing
countries mostly have a high volatile market due to low institutional quality. Duncan (2013)
argues that volatility can be due to either in support of monetary policies or its unsteadiness.
While Kaufmann et al. (2010) established the effect of governance indicators, Abdessatar
and Rachida (2013) examine the link between institutions’ quality and market volatility
measured by the Financial Stress Index and indicate that in developing countries strong
institutions reduce financial market instability. Using an index of institutional development
in China with property rights, quality of law enforcement and political pluralism, Hasan et
al. (2014) conclude that a negative association exists between stock price synchronicity and
property rights protection and rule of law. Eldomiaty et al. (2016) examine the associations
between Economic Freedom Index as a proxy for institutional quality and stock market
volatility and report that stock market volatility can be mitigated and reduced when
economic freedom is associated with effective enforcement of law and efficient
regulations. They further show that the high freedom from corruption results in active
equity trading which is associated with high volatility. In a similar vein, Gourio et al (2015)
explore the link between capital flows and stock markets for a sample of 26 emerging
market economies and find that stock market volatility is negatively related to capital
inflows.
Dooley and Hutchinson (2009) investigate the changing nature of correlations
between developed and emerging markets. They analyse several emerging and developed
countries and find evidence that correlations are increasing between both groups of
countries. They argue that emerging market volatility changes dramatically with the
liberalisation of economic policy (Jayasuriya 2005; Cunado et al. 2006; Fidrmuc and
Korhonen 2010). Additionally, Mun and Brooks (2012)’s investigation on 17 financial
 361

markets around the world shows that volatility plays an important role in explaining the
changing nature of stock market correlations during the GFC. They argue that countries
with higher GDP per capita exhibit lower stock market volatility. They find evidence of
strong links in GDP growth between the OECD countries, China, and India. This changing
nature of the business cycle relationship is also indicative of the possibility of correlations
between developed and emerging markets during and after the GFC (Fidrmuc and
Korhonen 2010). A large number of academic literature in recent years also find evidence
that stock market volatility increases during the GFC and, individual stocks became more
volatile in the emerging countries during that period. Stock markets synchronicity also
increases during this time and the individual stock becomes more synchronous, which is
more apparent in emerging economics (Hwang et al. 2013; John et al. 2010; Morck et al.
2000; Khandaker 2012). These findings support our view and suggest that stock market
volatility might be affected by the country-level variables (Jones et al. 1998; Fidrmuc and
Korhonen 2010). As such the following hypotheses have been designed to test in regards
to addressing our research objectives. Our first hypothesis analyses stock market time
series indexes/variables to determine whether the sample time series data was stationary
over the sample period. It is important to have non-stationary time series data to estimate
stock market volatility. The study applies a unit-root test in determining critical values of
unit root using trend line and constant, which is a standard practice in determining the unit
root in the sample time series data.

: The observed time series (Y) has a unit root, thus the series is not stationary.
: The observed time series (Y) does not have a unit root, thus the series is stationary.

The second hypothesis of this study analyses the correlation coefficient of the
volatility measures between emerging and developed stock markets over the sample period.
Dooley and Hutchinson (2009) find evidence that the correlation between developed and
emerging markets increases over the period. Sakthivel et al. (2012) investigate co-
movement of shock transmission and stock returns among markets of India, Japan, the
USA, Australia and the UK, and confirm the existence of bidirectional spillover of shocks
from Indian and the US Markets. Joshi (2011) found the evidence of bidirectional returns
spillover and fluctuation among stock markets of the Asian countries for Japan, South
Korea, Indonesia, China, Hong Kong, and India. Similarly, Beirne et al. (2013) investigate
the flow of shocks among newly emerged markets and developed markets and establish the
existence of clear substantiation regarding shock transmission from developed markets to
emerging markets. Furthermore, some studies also find that stock market volatility
increases during the GFC (Alter and Schüler 2012; Mun and Brooks 2012). Therefore, we
analyse the correlation coefficient between the sample countries volatility as the correlation
might change over time. Morck et al. (2000) suggest that a higher correlation contains
important information about the stock market volatility for emerging markets. We divide
the full-period data into several sub-periods to check whether the volatility measure
changes overtime during the GFC. The following hypothesis is developed to determine the
correlations between the stock market volatility for the sample countries.
 362

: Emerging and developed stock market volatility measures are statistically correlated
with each other during the GFC
: Emerging and developed stock market volatility measures are not statistically
correlated with each other during the GFC

The third hypothesis is developed to understand the changing pattern of the stock
market behaviour for the sample emerging country groups during the GFC. It is assumed
that emerging market exhibits higher stock market volatility, have therefore been more
volatile during the GFC. Emerging markets are often characterised by weak and
underdeveloped institutions that create higher transaction costs and make market-based
exchanges less efficient (Wright et al., 2005). Data from World Bank Group and
Transparency International, suggests that emerging countries are generally characterised
by poor governance with relatively high levels of corruption, political instability, low
regulatory quality, lack of accountability and general ineffectiveness of government
institutions (Kaufmann et al., 2010). As such, the quality of national governance and
institutional environment have an impact on stock market volatility. Morck et al (2000)
argue that poor developing economies cannot provide higher protection to the investor’s
rights, and due to poor governance mechanisms emerging stock markets are generally more
synchronous than developed economies. Therefore, there is evidence that stock markets of
emerging economies are more volatile than developed markets (Mun and Brooks 2012;
Khandaker 2012; Xing and Anderson 2011). Hence, the following hypothesis is formulated
to determine the level of stock market volatility in the emerging economies during the GFC:

: Our sample emerging countries exhibit higher stock market volatility during the
GFC.

: Our sample emerging countries do not exhibit higher stock market volatility during
the GFC
It is argued by several scholars that poor economies with less developed capital
market exhibit higher stock return synchronicity thus, higher stock price volatility. For
example, Morck et al. (2000) and La-Porte et al. (1998) find evidence that emerging
markets generally have higher inflation and corruption rate, and lower GDP per capita and
corporate governance mechanisms due to less developed capital market structure. They
argue that poor macro-economic variables and low institutional quality country-level
governance mechanisms are positively correlated with the stock market volatility. In fact,
countries with better-developed financial market institutions largely stimulate firm
growth and investments and increase stock market valuation (Oehmichen et al., 2017;
Rajan and Zingales, 1998). Generally, those countries perform better in the corporate
governance index also score higher in macroeconomic country-level variables, such as
Australia, Japan, Germany, France, the UK and the USA. Therefore, based on the above
discussion, we develop the following hypothesis:

: Stock market volatility is positively correlated with institutional quality country-level

governance mechanisms and macroeconomic variables.
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: Stock market volatility is negatively correlated with institutional quality country-

level governance mechanisms and macroeconomic variables.

RESEARCH METHODOLOGY

DATA

We use stock market data from seventeen countries, including seven emerging markets and
ten developed economies. We use the definition of the emerging and developed markets
based on the Financial Times Stock Exchange (FTSE) database. The emerging markets are
selected based on the equity market performance, market capitalisation and geographical
location. The emerging markets included in this study are China, India, Brazil, Indonesia,
Argentine, Mexico and Malaysia. China, India and Brazil are the ‘BIG Three’ emerging
countries and also included in ‘the BRIC’ country list. Other emerging countries listed in
our sample include Indonesia, Malaysia, Mexico and Argentina. Indonesia and Mexico are
newly industrialised economies and also included in ‘Next-11’ by ‘Goldman
Sachs Investment Bank’. The selection criteria of the ten developed economies (i.e.
Australia, France, Germany, Hong Kong, Japan, South Korea, New-Zealand, Singapore,
the USA and the UK) include geographical location, size of the equity market and the
availability of data from DataStream database.
The institutional quality country-level governance indicators used in this research
include Government Effectiveness (GEF), Regulatory Control (CON) and Rule of Law
(Law). These governance indicators are collected from the World Bank (WB) and
International Monetary Fund (IMF) database. According to the World Bank, Government
Effectiveness (GEF) is a combined indicator for the quality of public service provision,
bureaucracy and the independence of the civil service from political pressures. It is an
important indicator for our study because it includes the quality of information provision
and independences of government agencies (La-Porta et al. 1998; Katharina 2013; Becka,
et al. 2003; Atanasova, et al. 2010). Regulatory Control (CON) mainly focuses on price
stability, bank supervision, foreign trade and business development in a particular country.
It also includes the quality of regulations and investor protection rights, which is an
important factor for determining the countries compliance with the government indicators.
The Rule of Law (LAW) measures the incidence of crime, effectiveness & predictability of
the judiciary system and the enforceability of contracts within a country. These indicators
are measured in units ranging from -2.5 to +2.5. Higher values correspond to better
governance outcomes and institutional quality while lower values correspond to poorer
outcomes and institutional quality. The study also includes the corruption perception index
produced by Transparency International, Germany. According to Transparency
International (TI) corruption index is based on the past three year’s corruption perception
data collected from individual countries. The study employs GDP per capita and inflation
index as determinant factors of the stock market volatility in emerging and developed
countries. The GDP per capita and inflation data are collected from the International
Monetary Fund (IMF) and the World-Bank database. We also use unemployment, Co2
emission, tax revenue, agricultural value-added, bank capital, board money, budget
surplus/deficit, credit depth information, current account balance, total exports, total
imports, tourism receipt and market capitalisation. These data for the cross-sectional
 364

analysis are collected from the World Bank and IMF database. Table 1 illustrates the
number of listed firms that include in our research for the sample countries. The study uses
all available listed firms in the DataStream database for the analysis of stock market
volatility. The sampled shares include both dead and live stocks from the DataStream
database to avoid the survivorship bias problem.

TABLE 1: NUMBER OF LISTED FIRMS FROM THE SAMPLE STOCK

MARKETS
Developed Markets Emerging Markets
Country No of firms Country No of firms
Australia (ASE) 2,122 Argentina 149
France 1,301 Brazil 525
Germany 765 China 932
Hong Kong 1,615 India 1,635
Japan 2,292 Indonesia 111
South Korea 777 Malaysia 230
New Zealand 250 Mexico 466
Singapore 776
UK 2,800
USA 3,596
Number of firms 16,294 Number of firms 4,048

THE VOLATILITY MODEL

Econometric modelling of volatility clustering is a very active area of research in finance

literature in recent years. Several studies have found that the simple GARCH (1, 1) model
provides a good first-hand approximation of the market volatility (Baillie and Bollerslev
1989; Bollerslev 1987; Engle and Bollerslev 1986). Further, Bollerslev (1987) and Engle
et al. (2013) suggest that ARCH and stochastic volatility models provide a good volatility
forecast for market-wide volatility. We use the empirical standard volatility model to
determine the market-wide historical volatility adopted by Jones et al. (1998), Andersen
and Bollerslev (1997) and Andersen and Bollerslev (1998a). Given that this research aims
to determine the market-wide historical volatility rather than a better-fitted volatility model
for future forecasting, the historical volatility model is more important and useful for the
analysis. Now, consider a set of historical prices for some underlying asset that follow the
processes in equation (i):

S0 , S1,........,St 

The analysis began by the log price relatives, i.e. the percentage price changes express as
continuously compounded rates.
 365

Rt  ln S t / S t 1 

The estimate of the (constant) mean  of the Rt is the simple average:

R 
R t
(i)
T

The variance of the Rt is given by:

v2 
 Rt  R 2 (ii)
 T 1 

Annualizing the variance by multiplying by N, the number of price observations

in a year and taking the square root of the volatility:

 N v2 (iii)

The above procedure gives the best estimates of the volatility that can be obtained
from the available price data. This number then becomes the forecast for volatility going
forward, over a time horizon of any length.

PANEL DATA MODEL

Our study uses several independent variables collected from different sources to explain
stock market volatility during and after the global financial crisis. We employ the following
multi-variable regression model to analyse stock market volatility for the sample countries:

VOLT it     1 EFFit   2 CON it   3 LAW it   4 CORR it   5 GDPit   6 INFit   7 EMPit 

 8 CO 2 it   9 TAX it  10 AGRit  11 BNK it  12 BRDMOit  13 BUDit  14 CRI it  15 CAit 
16 EXPit  17 IMPit  18 TOUR it  19 MKTCAPit   it
(iv)

Where: VOLT is the share market volatility for country at time , EFF is the Govt.
effectiveness, CON is the regulatory control, LAW is the rule of law, CORR is the
corruption perception index (TI), GDP is the Gross Domestic Product per capita, INF is
the consumer price inflation rate, EMP is unemployment rate (percentage of total labour
force), C02 is Co2 emission (metric tons per capita) per country, TAX is the percentage of
 366

tax revenue (percentage of GDP), AGR is the agricultural value added (percentage of
annual growth), BNK is the bank capital to asset ratio in percentage, BRDMO is the broad
money as a percentage of GDP, BUD is the budget surplus or deficit (percentage of GDP),
CRI is credit depth information index (0=low, 6=High), CA is current account balance
(percentage of GDP), EXP is the exports of goods and services (percentage of GDP), IMP
is imports of Goods and services (percentage of GDP), TOUR is international tourism
receipt (percentage of total exports) and MKTCAP is market capitalisation of the listed
companies (percentage of GDP).

RESULTS

DESCRIPTIVE STATISTICS

Table-2 illustrates the descriptive statistics of the observed stock market’s volatility from
2001 to 2012. We find evidence that China and Indonesia reveal higher stock volatility
during the full study period. China exhibits the average volatility of 0.659 and Indonesia
exhibits 0.656 during the sample period with a higher standard deviation. The countries
exhibit a lower level of stock market volatility during the sample period include New
Zealand (0.1061) and Singapore (0.1834) with lower standard deviation.

TABLE 2: DESCRIPTIVE STATISTICS OF THE SAMPLE STOCK MARKET

TIME SERIES DATA

N Minimum Maximum Mean Std. Deviation Variance

Argentina 12 .2284 .4998 .3296 .1023 .010
Australia 12 .1498 .6761 .3116 .1572 .025
Brazil 12 .2037 .5237 .2882 .0852 .007
China 12 .3076 1.4752 .6592 .3104 .096
France 12 .1093 .4048 .2352 .0880 .008
Germany 12 .1213 .4006 .2415 .0938 .009
Hong Kong 12 .1154 .5074 .2293 .1071 .011
India 12 .1474 .4577 .2412 .0893 .008
Indonesia 12 .3381 1.2679 .6561 .2509 .063
Japan 12 .1359 .4686 .2371 .0868 .008
South Korea 12 .1517 .3952 .2467 .0776 .006
Malaysia 12 .1224 .5370 .3409 .1436 .021
Mexico 12 .1163 .3605 .2042 .0678 .005
New Zealand 12 .0663 .1976 .1061 .0352 .001
Singapore 12 .0964 .3529 .1834 .0735 .005
UK 12 .1872 .8489 .3885 .1765 .031
USA 12 .2161 .8632 .4116 .1845 .034
Average 0.3124
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The average stock market volatility for all countries during the full sample period
is 0.31237, and the USA (0.41159) and the UK (0.38850) exhibit higher stock market
volatility during the sample period. To examine whether the share market volatility
increases during the GFC or not, the full data series further divided into six sub-periods
included in Table 3. Each of these sub-periods includes two years of average stock
volatility data. Sub-Period 1 spans the time frame from January 2001 to December 2002
(9/11 crisis), Sub-period 2 is from January 2003 to December 2004 (post 9/11 crisis), Sub-
period 3 is from January 2005 to December 2006 (stability in the financial markets, pre-
GFC crisis), Sub-period 4 is from January 2007 to December 2008 (GFC), Sub-period 5 is
from January 2009 to December 2010 (European debt crisis) and Sub-period 6 is from
January 2011 to December 2012 (post-GFC and European Debt Crisis). We find that China
and Indonesia exhibit higher stock market volatility during the observation period and this
effect is also visible when the time-series data is divided into six sub-periods. For example,
Indonesia exhibits the stock market volatility of 0.8745, 0.5925, 0.5042, 0.9305, 0.5696
and 0.4651, and China exhibits the stock market volatility 0.6426, 0.6189, 0.4238, 1.1480,
0.6530 and 0.4687 during the observed sub-periods. These volatility measures are among
the highest of all sample countries. Further, our sample stock markets exhibit higher
volatility during 2007-2008 (during the GFC) except for France and Germany. The average
stock market volatility during this period is 0.4483, which is among the highest in all sub-
periods. Interestingly, the average stock market volatility during 2005-06 (sub-period 3)
was only 0.2143, which is the lowest in all sub-periods. We assume this is due to the
worldwide economic stability during this 2005-06 period. Countries exhibit higher stock
market volatility during 2009-2010 include Malaysia, Mexico, New-Zealand, Singapore,
the UK and the USA. This suggests a large number of sample emerging and developed
economies remain volatile after the GFC, which is mainly driven by the European Debt
Crisis. However, the average stock market volatility has reduced to 0.2610 in 2011-2012
due to the end of GFC and the European Debt Crisis.

TABLE 3: STOCK MARKETS VOLATILITY FOR THE OBSERVED SUB-

PERIODS FROM 2001 TILL 2012

Sub Sub Sub Sub Sub Sub

Period 1 Period 2 Period 3 Period 4 Period 5 Period 6
Year 2001-02 2003-04 2005-06 2007-08 2009-2010 2011-2012
Argentina 0.4986 0.3126 0.2402 0.3448 0.3016 0.2797
Australia 0.2244 0.1737 0.2238 0.5057 0.4368 0.3049
Brazil 0.3327 0.2639 0.2456 0.3998 0.2546 0.2322
China 0.6426 0.6189 0.4238 1.1480 0.6530 0.4687
France 0.3069 0.1949 0.1285 0.2874 0.2478 0.2459
Germany 0.3438 0.2321 0.1379 0.2653 0.2322 0.2375
Hong Kong 0.2368 0.1663 0.1297 0.3835 0.2504 0.2095
India 0.2252 0.2225 0.2172 0.3516 0.2518 0.1787
Indonesia 0.8745 0.5925 0.5042 0.9305 0.5696 0.4651
Japan 0.2757 0.2057 0.1674 0.3273 0.2444 0.2019
 368

Korea. 0.3338 0.2480 0.1751 0.3137 0.1990 0.2104

South
Malaysia 0.3889 0.2897 0.1816 0.4533 0.5242 0.2080
Mexico 0.2295 0.1454 0.1977 0.2889 0.2065 0.1570
New- 0.1140 0.0751 0.0989 0.1496 0.1090 0.0903
Zealand
Singapore 0.2066 0.1519 0.1162 0.2845 0.1955 0.1457
UK 0.4335 0.2643 0.2262 0.5885 0.4407 0.3778
USA 0.4391 0.2715 0.2293 0.5990 0.5075 0.4231
Average
0.3592 0.2605 0.2143 0.4483 0.3309 0.2610

ANALYSIS OF THE SHARE MARKETS TRENDS

The first hypothesis of our paper assumes that the stock market time-series data have a
constant unit root. We use ‘Augmented Dickey-Fuller’ (ADF) test statistics to determine
the critical values of the unit root using trend line and constant. According to the ADF test
statistics conditions, if the absolute test value is more than the critical value, then the null
hypothesis should be rejected, and the alternative hypothesis should be accepted. Table 4
illustrates the ADF test statistics values for the sample stock markets with ‘trend and
intercept’.

TABLE 4: AUGMENTED DICKEY-FULLER TEST STATISTICS FOR THE

SAMPLE STOCK MARKER SERIES

Country Trend and Intercept

Argentina -35.63551
Australia -56.74610
Brazil -55.64848
China -25.23184
France -59.00623
Germany -56.31221
Hong Kong -57.20119
India -51.44899
Indonesia -51.15349
Japan -55.78064
South Korea -53.56306
Malaysia -12.68699
Mexico -52.18950
New Zealand -50.58754
Singapore -56.58810
UK -35.64175
USA -59.17460
 369

If the test statistics are less than the critical value we need to accept the null hypothesis.
Our first null hypothesis is, ‘The observed time series (Y) has a unit root, and thus the
series is not stationary.’ After analysing all individual data series for each observed stock
market, we find that each observed time series variable do not have a constant mean and
variance, so the series are not stationary at 1 level of difference
Additionally, to understand the time-series pattern of the selected stock market
data, figure 1 incorporates the visual presentation of the three emerging countries (i.e.
China, Indonesia and Malaysia) and, three developed countries (i.e. the UK, the USA and
Japan) stock market time-series data. The Graph represents stock markets index points in
the Y-axis in local currency and the number of days in Y-axis. The study uses 30 days
moving average to smooth-out the observed time series. We find evidence that the sample
emerging and developed stock markets inclined significantly just before the GFC, though
the development did not sustain. The tremendous impact of the GFC has forced the
developed and emerging economies to readjust their capital market structure, and
eventually invited them for a financial market crash. For example, NYSE, USA have
climbed to 10,194.01 points in June 2007 from 7,780.33 in June 2006 and then dropped to
4,226.31 points in March 2009. The other stock exchanges in the emerging and developed
markets have followed the same trend.

50,000

40,000

30,000

20,000

10,000

0
500 1000 1500 2000 2500 3000

CHINA INDONESIA JAPAN

MALAYSIA USA UK

Figure 1: Stock Markets Trends in China, Indonesia, Japan, Malaysia, the UK and the
USA (2001-2012).
 370

CORRELATIONS MATRIX

Table A1 in the appendix illustrates the correlation coefficient between the time series
variables for the observed developed and emerging countries. There is evidence that the
majority of the sample stock markets exhibit a positive relationship with each other at the
1 per cent significance level. The result is very interesting as it shows strong positive
correlations among the sample stock markets during and after the GFC. This effect appears
at 5 per cent level for Brazil with Japan and India with France. However, this effect is not
statistically significant for Malaysia with France, and Japan with Mexico. The results
provide evidence that the sample developed and emerging market time-series data are
positively correlated during the sample period. The effect became more apparent during
the GFC for the emerging country group.

PANEL DATA ANALYSIS

ORDINARY LEAST SQUARE MODEL

We employ a multivariate regression model to analyse share market volatility for the
sample period using the equation iv . Table 5 presents the regression results of the stock
market volatility for the sample countries with a balanced panel data and simple ordinary
least squares (OLS) linear regression method for the analysis.
With regard to institutional quality country-level governance indicators, it is
found that stock market volatility is significantly negatively associated with the rule of law
(LAW) at 5 per cent significance level with a higher coefficient (-0.20497), suggesting that
the higher is the quality of rule of law (i.e. effectiveness of the judiciary system and the
enforceability of contracts) within a country, the lower would be stock market volatility.
This finding is as per expectation and consistent with the previous literature. However,
other institutional-quality governance indicators show an insignificant relationship with
stock market volatility, indicating no deterrent effect on stock market volatility.

TABLE 5: DETERMINANTS OF STOCK MARKET VOLATILITY: CROSS-

SECTIONAL ANALYSIS - (OLS METHOD)

Std.
Variable Coefficient Error t-Statistic Prob.
Constant 0.13983 0.17223 0.81185 0.4192
Government Effectiveness (EFE) -0.00814 0.12923 -0.06295 0.9500
Regulatory Control (CON) 0.02143 0.08094 0.26471 0.7919
Rule of Law (LAW) -0.20497 0.10060 -2.03746 0.0448
Corruption (CORR) 0.02549 0.02837 0.89839 0.3716
GDP per capita (GDP) -3.43060 2.56060 -1.34158 0.1834
Inflation (INF) -0.00090 0.00974 -0.09243 0.9266
Unemployment (EMP) 0.00642 0.00946 0.67951 0.4987
C02 emission (CO2) 0.03130 0.00792 3.95247 0.0002
Tax Revenue (TAX) 0.00836 0.00469 1.78358 0.0782
Agricultural Value (AGR) 0.00637 0.00445 1.43297 0.1557
 371

Bank Capital (BNK) 0.00977 0.01297 0.75319 0.4535

Board Money (BRDMO) 0.00144 0.00055 2.60103 0.0110
Budget Surplus/Deficit (BUD) -0.00205 0.00669 -0.30675 0.7598
Credit Depth Information (CRI) -0.06215 0.01698 -3.65983 0.0004
Current Account Balance (CA) -0.00318 0.01199 -0.26487 0.7918
Exports (EXP) 0.00582 0.00815 0.71426 0.4771
Imports (IMP) -0.00740 0.00830 -0.89122 0.3754
Tourism (TOUR) -0.01394 0.00932 -1.49486 0.1388
Market capitalisation (MKTCAP) 0.00032 0.00041 0.76424 0.4469
R-squared 0.45487
Adjusted R-squared 0.14775
F-statistic 3.60113
Prob(F-statistic) 0.00003

Further, in regards to the traditional and non-traditional macroeconomic factors, ordinary

least squares (OLS) regression results reveal that only the credit depth information index
variable (CRI) has a significantly negative effect (-0.06215) on stock market volatility 1
per cent significance level. As CRI covers vital information about countries financial
structure and strength in paying debt related obligation, this finding suggests that countries
with a higher score in this index can deter stock market volatility through investment
opportunity for the international and local investors. However, a few other macroeconomic
variables although demonstrate negative coefficients, but with no statistical significance.
In contrast, Co2 carbon emission (CO2) is positively correlated (0.031) with the stock
market volatility at 1 per cent significance level. This finding is new and deserves due
attention, given that no prior studies used Co2 carbon emission for determining the stock
market volatility. Interestingly in our sample countries, Australia, the UK and the USA
produce the highest Co2 emission and exhibit higher stock market volatility during the
GFC. Similarly, board money (BRDMO) is significantly positively related (0.00144) to the
stock market volatility at 1 per cent significance level, suggesting that BRDMO (i.e. M2,
M3, and M4 of the money supply) plays a vital role in the stock market behaviour and a
higher percentage of board money can accelerate stock market volatility and vice-versa.
Finally, tax revenue (TAX) also reveals a positive effect (0.00836) on stock market
volatility though weak at 10 per cent significance level. This result is contrary to
expectation, as it is assumed that higher tax revenue is negatively correlated with stock
market volatility.

FIXED-EFFECTS MODEL

It has been recognised in the literature that with balanced panel data structure ordinary least
square linear regression may be inconsistent and meaningless if there exists heterogeneity
across firms (Hsiao, 2003). So, the results could be biased and spurious, because the model
has an unobservable heterogeneity issue and it only treats data as cross-sectional, ignoring
the panel structure (Arellano and Honore, 2001). To solve this problem, this study applies
a fixed-effects model for determining the stock market volatility and its effect on the
country level variables using the equation iv after controlling for possible unobserved firm-
 372

level heterogeneities. Table 6 illustrates the results of the fixed-effects model showing
many plausible findings as per expectation than that reported in Table 5.

TABLE 6: DETERMINANTS OF STOCK MARKET VOLATILITY: PANEL

DATA ANALYSIS- (FIXED-EFFECTS METHOD)

t-
Variable Coefficient Std. Error Statistic Prob.
0.17297 0.16466 1.05046 0.2968
Constant
-0.08419 0.11936 -0.70531 0.4827
Government Effectiveness (EFE)
0.04730 0.07365 0.64214 0.5227
Regulatory Control (CON)
-0.16077 0.09010 -1.78430 0.0783
Rule of Law (LAW)
0.02075 0.02544 0.81568 0.4172
Corruption (CORR)
-3.33000 2.8100 -1.18526 0.2396
GDP per capita (GDP)
0.00159 0.00882 0.18029 0.8574
Inflation (INF)
0.00373 0.00870 0.42872 0.6693
Unemployment (EMP)
0.03086 0.00775 3.98439 0.0002
C02 emission (CO2)
0.00817 0.00453 1.80061 0.0757
Tax Revenue (TAX)
0.00394 0.00404 0.97558 0.3323
Agricultural Value (AGR)
0.00704 0.01178 0.59749 0.5519
Bank Capital (BNK)
0.00140 0.00051 2.71998 0.0081
Board Money (BRDMO)
-0.00561 0.00681 -0.82459 0.4122
Budget Surplus/Deficit (BUD)
-0.05774 0.01559 -3.70315 0.0004
Credit Depth Information (CRI)
0.00106 0.01079 0.09778 0.9224
Current Account Balance (CA)
0.00381 0.00731 0.52149 0.6035
Exports (EXP)
-0.00513 0.00750 -0.68415 0.4959
Imports (IMP)
-0.00952 0.00863 -1.10387 0.2731
Tourism (TOUR)
0.00019 0.00043 0.45460 0.6507
Market capitalisation (MKTCAP)
R-squared 0.59848
Adjusted R-squared 0.47333
4.78217
F-statistic
0.00000
Prob(F-statistic)

ROBUSTNESS TEST

For the robustness test, we run the equation iv by removing one predictor variable at a
time to determine the impact of that predictor variable in the model. The un-tabulated
results indicate qualitatively similar findings and the effect remains constant without much
 373

variation when removing a single variable from the model at various panels. The findings
suggest that our sample developed, and emerging countries were volatile during the GFC
and several macroeconomic variables come into play during the period and accelerate the
crisis. We also run separate regression for developed countries and emerging countries in
our sample, however, results are not consistent with our baseline findings as reported in
Table 6 with fixed-effects models. Such inconsistency of findings in distinct sample
country groups indicates high co-integration and co-movement of economic effects across
the stock markets of the countries in a globalised world irrespective of developed and
emerging.

CONCLUSIONS

In this paper, we examine the stock market volatility in the sample emerging and developed
economies during the GFC and also analyse the impact of institutional quality country-
level governance indicators and macroeconomic factors on the stock market volatility. We
find evidence that stock markets around the world were volatile during the GFC and these
effects were statistically significant for the sample emerging countries as well as developed
countries. We also find that stock return time-series variables were not stationary over the
study period at 1 per cent level of difference.
We find evidence of stock market volatility during the observation period to
support our hypothesis that the sample stock markets were volatile during the GFC. Again,
we find evidence that emerging stock markets exhibit higher stock market volatility during
the observation period than the developed economies. Further grouping of six sub-periods
documents that the average stock market volatility was highest in 2007-08 and 2009-2010
for the sample stock markets. These findings generally support our first three hypotheses.
Aligned with institutional theory, we also document that several institutional quality
country-level governance indicators and macroeconomic variables are statistically
correlated with the stock market volatility during the observation period, thus support the
last hypothesis. Relying on fixed-effects regression for panel data analysis, we determine
the impact of institutional quality and macroeconomic explanatory variables on the stock
market volatility during the GFC. We find that rule of law, and credit information, have a
significant negative association with the stock market’s volatility as expected. Further, we
find some interesting result in panel analysis using the fixed effect model. For example,
Co2 emission is significantly positively correlated with the stock market volatility with tax
revenue, and board money.
Our findings have several policy implications. First, we provide evidence that
stock markets of the developed and emerging countries were volatile during the GFC.
Second, the rule of law appears dominant in deterring the stock market volatility. Third, a
number of macroeconomic as well as monetary and fiscal factors including Co2 emission
may seem to be a potential barrier for international investment and portfolio diversification.
 374

APPENDIX
TABLE A1: CORRELATION-COEFFICIENT BETWEEN THE TIME SERIES DATA
FOR THE OBSERVED COUNTRIES.
 375

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