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Applied Financial Economics

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International linkages of the Chinese stock exchanges:

a multivariate GARCH analysis
a
Hong Li
a
School of Economics, Kingston University , Surrey KT1 2EE , UK E-mail:
Published online: 14 Mar 2007.

To cite this article: Hong Li (2007) International linkages of the Chinese stock exchanges: a multivariate GARCH analysis,
Applied Financial Economics, 17:4, 285-297, DOI: 10.1080/09603100600675557

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 Applied Financial Economics, 2007, 17, 285–297

International linkages of the Chinese

stock exchanges: a multivariate
GARCH analysis
Hong Li
School of Economics, Kingston University, Surrey KT1 2EE, UK
E-mail: h.li@kingston.ac.uk
Downloaded by [Central Michigan University] at 09:25 08 October 2014

This paper examines the linkages between the two emerging stock
exchanges in mainland China and the established markets in Hong Kong
and in the US by a multivariate GARCH approach. We use a four-variable
asymmetric GARCH in the line of the BEKK model proposed by Engle
and Kroner (1995) to account for the regularities documented in the share
price indices and test for the transmission of returns and volatility across
the markets. While we do not find any evidence of a direct linkage between
the stock exchanges in mainland China and the US market, we find
evidence of uni-directional volatility spillovers from the stock exchange in
Hong Kong to those in Shanghai and Shenzhen. However, the magnitude
of the volatility linkages between the mainland and Hong Kong is small,
indicating a weak integration of the Chinese stock exchanges with the
regional developed market. The implication of the weak integration is that
overseas investors will benefit from the reduction of diversifiable risk, and
thus total portfolio risk, by adding the mainland Chinese stocks to their
investment portfolio.

I. Introduction of capital. If, on the contrary, the Chinese stock

This article models the Chinese stock exchanges in a
setting of overseas influences and investigates how
and to what extent the stock exchanges in mainland
China are linked to the developed markets in Hong
Kong1 and in the United States. The extent of linkage
of the Chinese stock exchanges with overseas markets
has great implications for domestic firms and over-
seas investors. If the Chinese stock exchange is fully
integrated with the international market, the expected
returns of the mainland Chinese stocks will be mainly
determined by the world undiversifiable risk. Hence
asset volatility in the Chinese stock market will
decline and domestic firms will benefit from low cost
exchange is only weakly integrated with the
international market, overseas economic conditions
will have less influence in mainland China. If the
returns generated in mainland Chinese markets do
not move together with those of overseas markets,
then overseas investors will benefit from the
reduction of diversifiable risk, hence the portfolio
risk, by diversification that includes the Chinese
stocks.
Although the Chinese economy is closely linked to
the rest of world through international trade and
foreign direct investment, a question remains about
the extent of global integration of the Chinese capital
market. The stock exchanges in mainland China,2

1
Under the taxonomy of Morgan Stanley Capital International, Hong Kong is categorized as a developed market.
2
See Wang et al. (2004) for a description of the institutional background and the structure of the Chinese stock exchanges and
Seddighi et al (2004) for a detailed account of the operations of the Chinese stock exchanges.
Applied Financial Economics ISSN 0960–3107 print/ISSN 1466–4305 online ß 2007 Taylor & Francis 285
http://www.tandf.co.uk/journals
DOI: 10.1080/09603100600675557
 286
namely the Shanghai stock exchange and the
Shenzhen stock exchange, were established about
10 years after China adopted an Open Door policy in
1978. The Shanghai stock exchange started trading
on 19 December 1990 while the Shenzhen stock
exchange started trading on 3 July 1991.
International investors, including overseas Chinese
residing in Hong Kong, Macau and Taiwan, can only
participate in the trading of B shares3 of the listed
companies in the Chinese stock exchanges. This direct
form of investment barrier applied to overseas
investors may have made the Chinese stock
exchanges at least mildly segmented from the inter-
national capital market. However, documenting the
existence of barriers to investment is insufficient to
prove the degree of segmentation as investors may
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find innovative ways to circumvent legal restrictions.
Determining the extent to which a national equity
market is linked with the international market is thus
an empirical question of great interest to researchers
and investors.
Although stock market integration among devel-
oped countries has been widely studied,4 research on
the international linkages of the Chinese stock
exchanges is limited. Chow and Lawler (2003) carry
out a comparative analysis of the weekly composite
indices from the Shanghai and the New York stock
exchanges during 1992–2002 by a multiple regression
approach in order to examine the extent of global
integration of the Chinese stock exchange. As they do
not find any evidence of positive correlation between
Shanghai and New York in the regression of rate of
returns and volatility, they conclude that the
Shanghai and the New York markets are not
integrated. However, their study does not investigate
the possibility that the Shanghai stock exchange is
indirectly integrated with the New York market
through the regional developed market in Hong
Kong. Moreover, the estimates of the relationship
by ordinary least squares used in their study may be
inconsistent due to the fact that it fails to capture the
autoregressive second moment of the distribution of
stock returns. If the extent of integration is measured
by the relation in the first and second moments of
share price indices between stock exchanges, the
multivariate GARCH models allowing time-varying
variance-covariance, e.g. the BEKK model (the
acronym from synthesized work on multivariate
models by Baba, Engle, Kraft and Kroner) proposed
by Engle and Kroner (1995), should be applicable.
3
B shares are issued by mainland Chinese companies in either mainland Chinese stock exchange, denominated in RMB Yuan
but traded in foreign currencies. Since March 2001, B shares have been opened to domestic investors.
4
See Heimonen (2002) for a review of the studies on stock market integration and the methodology adopted by the studies.
H. Li
There have been several applications of
multivariate, mostly bivariate, GARCH models to
the investigation of interrelation between markets.
Chou et al. (1999) use a bivariate BEKK model to
test the relationship in volatility between the
Taiwanese and the New York stock exchanges and
find evidence supporting the conventional expecta-
tion that volatility spills over from the developed
market in the New York to the emerging market in
Taiwan. Kasch-Haroutounian and Price (2001) also
find a unidirectional volatility spillover from Poland
to Hungary in their bivariate BEKK model.
Miyakoshi (2003) includes the returns of the US
market as an exogenous variable in a bivariate
GARCH model, i.e. some Asian markets vs.
Japanese market, to examine how and to what
extent the Asian markets are influenced by the
regional (Japan) and international (US) markets. He
finds that the returns in the Asian markets are
influenced only by the US market, but volatility of
the Asian market is influenced more by the Japanese
market than by the United States. There further
exists an adverse influence of volatility from the
Asian market to the Japanese market. Worthington
and Higgs (2004) examine the transmission of equity
returns and volatility among nine Asian developed
and emerging markets by a nine-variable GARCH
model. They find evidence of return spillover of
small magnitude from the developed to emerging
markets and of large magnitude within the emerging
markets. Own volatility persistence is found to be
stronger than the cross-market volatility spillover.
As far as China is concerned, there are also studies
using GARCH models, but they are carried out in
a setting without regional or global influences.
For instance, Brooks and Ragunathan (2003) and
Wang et al. (2004) use a GARCH model to
investigate the interactions between Chinese A and
B shares traded on the Shanghai and the Shenzhen
stock exchanges. These studies reveal the interactions
and the behaviour of investors within the Chinese
stock exchanges. However, in this study, we are
interested in the relationship between the mainland
Chinese stock markets and the overseas markets,
which will have important implications for decisions
concerning international asset allocation and risk
diversification. We will model the returns and
volatility of the Shanghai composite index and the
Shenzhen component index in the setting of the
influence of the Hang Seng index and the S&P
500 index. To estimate returns and volatility
 International linkages of the Chinese stock exchanges
simultaneously and systematically for the four
markets, we will use a four-variable GARCH
model, augmented with a dynamic mean equation
and the BEKK conditional variance–covariance
equation incorporating asymmetric responses. In
addition to modelling directly the first and second
moments of the share price indices, this method
estimates the cross-market effects more consistently
than the method used in Chow and Lawler (2003).
We will examine not only to what extent but also how
the mainland Chinese stock exchanges are linked to
the overseas markets.
The remainder of the article is organized as follows.
Section II examines the features of the Chinese share
price indices against the Hang Seng index and the
S&P 500 index by graphical inspection and the
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summary statistics. On the basis of the observations
in Section II, Section III presents the methodology to
be used. Section IV reports the empirical results and
discusses their implications. Section V concludes.
II. Data and Preliminary Analysis
In this article, the raw data are the daily share price
indices of the stock markets in Shanghai, Shenzhen,
Hong Kong and the United States from 4 January
2000 to 17 August 2005. We remove the data of the
dates when any series has a missing value due to no
trading. Thus all the data are collected on the same
dates across the stock exchanges and there are 1344
observations for each series. The period under study
is recent and avoids any abnormal behaviour caused
by the Asian financial crisis in 1997. The indices used
in this study are the widely accepted benchmark
indices for the four stock exchanges. The Shanghai
composite index captures the price movement of all
the shares, including A shares and B shares, listed in
the Shanghai stock exchange. The Shenzhen compo-
nent index, on the other hand, is calculated for those
heavily traded A and B shares in the Shenzhen stock
exchange. For the stock exchange of Hong Kong, we
use the Hang Seng index, which includes the 33
largest firms in Hong Kong and represents about
75% of the total equity capitalization for the Stock
Exchange of Hong Kong. The S&P 500 index tracks
500 companies in leading industries and services and
is considered as the most accurate reflection of the US
stock market today. All the data are closing
price adjusted for dividends and splits. They are
5
http://www.finance.yahoo.com.cn
287
value-weighted arithmetic indices and are down-
loaded from the website of Yahoo Finance.5
The two mainland stock exchanges included in this
study are the only existing ones in mainland China.
The stock exchanges in Shanghai and Shenzhen
remain distinct due to the restriction that dual listing
is not allowed. The Hang Seng index is included
in the study not only because of the close trade
relationship between Hong Kong and mainland
China but also the fact that most of the listed
companies have direct or indirect investment in
mainland China. Hong Kong is regarded as one of
the mature financial centres and plays an important
role in the regional economy of the southeastern Asia.
The S&P index is included to represent the global
financial centre. The inclusion of the Hang Seng
index and the S&P 500 index, therefore, helps
investigate the integration of the Chinese capital
market with the regional and global capital markets.
Figure 1 presents the time plot of the series,
which fluctuate on a daily and longer term basis.
The first impression is that the two mainland Chinese
indices follow a similar movement while the Hang
Seng and S&P indices have a similar trend. During
mid-2001, all the four series started to turn down-
wards. But towards the end of the period under study,
i.e. mid-2004, the Hang Seng index and the S&P 500
index are trending upwards while the Shanghai
composite index and the Shenzhen component index
are trending downwards.
Figure 2 indicates that the returns of the share price
indices, the first differences of the natural logarithm
of the share price indices, have the features of
volatility clustering, i.e. large (small) volatility fol-
lowed by large (small) volatility, and conditional
heteroscadasticity common to the financial variables.
As the cluster, especially between the Shanghai
composite and Shenzhen component indices and
between the Hang Seng and the S&P 500 indices,
tends to occur simultaneously, volatility must be
modelled systematically.
Table 1 reports summary statistics for the returns
series. During the period under study, the perfor-
mance of the shares listed across the four stock
exchanges is disappointing with negative returns, the
average daily returns of the Hang Seng index
decreasing most slowly. The three Chinese indices
are equally volatile, as measured by the standard
deviations of 1.4–1.5%, while the S&P 500 index is
the least volatile at the standard deviation of 1.2%.
The Jarque–Bera statistics reject the null hypothesis
that the returns are normally distributed for all cases.
 288 H. Li
Shanghai Shenzhen
2400 5500

2200 5000
2000
4500
1800
4000
1600
3500
1400

1200 3000

1000 2500
2000 2001 2002 2003 2004 2000 2001 2002 2003 2004

Hang Seng S&P 500

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20000 1600
1500
18000
1400
16000 1300
1200
14000
1100
12000 1000
900
10000
800
8000 700
2000 2001 2002 2003 2004 2000 2001 2002 2003 2004
Fig. 1. Share price indices

The indices of the two Chinese mainland stock
exchanges have a positive skewness, indicating that
large positive stock returns are more common than
large negative returns. The S&P 500 index is slightly
positively skewed, too. In contrast, the Hang Seng
index is slightly negatively skewed. When modelling
with GARCH, the nonzero skewness statistics
indicate an ARCH order higher than one in the
conditional variance equation. Subsequently, a
GARCH(1,1) model should be preferred to an
ARCH(p) model for the sake of parsimony.
All the return series are leptokurtic, having signifi-
cantly fatter tails and higher peaks, as the kurtosis
statistics are greater than 3. GARCH models are
capable of dealing with data displaying the above
features.
III. Methodology
The variable of interest in this study is the daily
returns on the share price indices, which are
computed as first differences of natural logarithm of
the four share price indices. On the basis of the
features observed in the previous section, GARCH
models will be appropriate. As the aim of the study is
to consider the interdependence across the four stock
exchanges, we will use a multivariate GARCH model
in the style of the BEKK proposed by Engle and
Kroner (1995). Specifically, the following model is
used to examine the joint processes relating to the
share price indices under study.
Yt ¼
þ Yt
1 þ "t , "t jIt
1  Nð0, Ht Þ ð1Þ
where Yt is a 4  1 vector of daily returns at time t
and is a 4  4 matrix of parameters associated with
the lagged returns. The diagonal elements in matrix
,  ii, measure the effect of own past returns while the
off-diagonal elements,  ij, capture the relation in
terms of returns across markets, also known as return
spillover. The 4  1 vector of random errors, "t, is the
innovation for each market at time t and has a 4  4
conditional variance–covariance matrix, Ht. The
market information available at time t
1 is repre-
sented by the information set It
1. The 4  1 vector,

, represents constants.
 International linkages of the Chinese stock exchanges 289
Shanghai Shenzhen
0.12 0.12

0.08
0.08

0.04
0.04
0.00
0.00
−0.04

−0.04
−0.08

−0.08 −0.12
2000 2001 2002 2003 2004 2000 2001 2002 2003 2004

Hang Seng S&P 500

0.08 0.06
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0.04
0.04
0.02
0.00 0.00

−0.04 −0.02

−0.04
−0.08
−0.06

−0.12 −0.08
2000 2001 2002 2003 2004 2000 2001 2002 2003 2004

Fig. 2. Returns of the share price indices

Table 1. Statistical properties of the returns series

Shanghai Shenzhen Hang Seng S&P 500

Mean
0.000123
9.05E-05
7.44E-05
0.000102
Median 0.000000 0.000000
0.000188 0.000222
Maximum 0.109599 0.116341 0.054342 0.055744
Minimum
0.065430
0.081680
0.106469
0.060045
Standard deviation 0.013915 0.014894 0.014176 0.012473
Skewness 0.972471 0.797667
0.493469 0.142497
Kurtosis 10.94047 10.87243 7.494808 5.010812
Jarque–Bera 3739.910 3610.448 1185.049 230.8049
Probability 0.000000 0.000000 0.000000 0.000000

Bollerslev et al. (1988) propose that Ht is a linear vector. The problems with this formulation are
function of the lagged squared errors and cross that the number of parameters to be estimated is
products of errors and lagged values of the elements large and the restrictions on the parameters are
of Ht as follows. needed to ensure that the conditional variance matrix
X
q is positive definite. Engle and Kroner (1995) propose
vechðHt Þ ¼ vechðC Þ þ Ai vechð"t
1 "0t
i Þ a new parametrization for Ht, i.e. the BEKK model,
i¼1 to overcome the above two problems.
X
p
þ Gi vechðHt
i Þ
i¼1
Ht ¼ C 0 C þ A0 "0t
1 "t
1 A þ G 0 Ht
1 G ð2Þ
where vech is the operator that stacks the lower The BEKK model provides cross-market effects in
triangular portion of a symmetric matrix into a the variance equation parsimoniously and also
 290
guarantees positive semi-definiteness by working with
quadratic forms. Kroner and Ng (1998) propose to
extend the BEKK model to allow for the asymmetric
responses of volatility, i.e. stock volatility tends to
rise more in response to negative shocks (bad news)
than positive shocks (good news), in the variances
and covariances.
Ht ¼ C 0 C þ A0 "0t
1 "t
1 A þ G 0 Ht
1 G þ D 0 t
1
0
t
1 D
ð3Þ
where t is defined as "t if "t is negative and zero
otherwise. The last item on the right-hand side
captures the asymmetric property of the time-varying
variance–covariance. The notation used in
Equation 3 is as follows. C is a 4  4 lower triangular
matrix of constants while A, G and D are 4  4
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H. Li
Marquardt algorithm is a modification of BHHH
that incorporates a ‘correction’, the effect of which is
to push the coefficient estimates more quickly to their
optimal values. The starting values of the parameters
in the mean equations and constants in the condi-
tional variance–covariance equations are obtained
from their corresponding univariate GARCH models
by a two-step estimation approach. The starting
values of the diagonal parameters in matrices A, G
and D are approximately 0.05, 0.9 and 0.2, respec-
tively, while the starting values of the off-diagonal
elements are zero. The maximum number of itera-
tions is 100 in this study while the convergence value
is 1e
5.
The estimation of nonlinear models like the
BEKK model involving maximizing the likelihood

matrices. The diagonal parameters in matrices A and
G measure the effects of own past shocks and past
volatility of market i on its conditional variance,
while the diagonal parameters in matrix D measure
the response of market i to its own past negative
shocks. The off-diagonal parameters in matrices A
and G, aij and gij, measure the cross-market effects in
volatility, also known as volatility spillover, while the
off-diagonal parameters, dij, measures the response
of market i to the negative shocks, i.e. bad news,
of other markets, to be called the cross-market
asymmetric responses.
Engle and Kroner (1995) and Kroner and Ng
(1998) state that the above BEKK systems can be
estimated efficiently and consistently using full
information maximum-likelihood method. The log-
likelihood function of the joint distribution is the sum
of all the log-likelihood functions of the conditional
distributions, i.e. the sum of the logs of the multi-
variate-normal distribution. Letting Lt be the log-
likelihood of observation t, n be the number of stock
exchanges and L be the joint log likelihood gives
X
T
L¼ Lt
t¼1
n 1 1
Lt ¼ lnð2Þ
lnjHt j
"0t H
1
t "t
2 2 2 the estimated results, we carry out the log-likelihood
A numerical procedure, e.g. BHHH algorithm, is
often used to maximize the log-likelihood function.
The maximum-likelihood estimate is then applied to
obtain the estimate of unknown parameters. In this
study, we choose the first derivative method of
Marquardt as the optimization algorithm. The
function is complicated due to the possible local
optima. Kasch-Haroutounian and Price (2001) report
difficulties in getting convergence when the BEKK
model is used to estimate volatility in the four
transition markets of central Europe. Nonetheless,
the difficulty in getting convergence is common to the
estimation of nonlinear models by the maximum-
likelihood method. The difficulty is more than
compensated by the flexibility of the BEKK model.
Any assumptions can be imposed to the full-set model
to suit the purpose of a specific investigation.
However, we bear in mind that the parameters
estimated by the BEKK model cannot be easily
interpreted, and their net effects on the variances and
covariances are not readily seen.
IV. Empirical Results
The mean Equation 1 and time-varying variance–
covariance Equation 3 are estimated simultaneously
by the maximum log-likelihood method. Note that
the stock exchanges in Shanghai, Shenzhen, Hong
Kong and the United States are, respectively, indexed
as 1, 2, 3 and 4. The four-variable asymmetric
ð4Þ GARCH model converges after 71 iterations and its
results are reported in Table 2. Before we discuss
ratio test to see if the four returns series
should have been estimated simultaneously by the
BEKK approach. As the statistic, reported in
Table 3,6 from the log likelihood ratio test for the
four-variable asymmetric GARCH model versus the
univariate asymmetric GARCH model is 3148.4077,

6
Results of the restriction tests about the four-variable asymmetric GARCH model are gathered together and presented in
Table 3.
 International linkages of the Chinese stock exchanges 291
Table 2. Estimated coefficients for the four-variable asymmetric GARCH model

Shanghai (i ¼ 1) Shenzhen (i ¼ 2) Hang Seng (i ¼ 3) S&P 500 (i ¼ 4)

 i1
0.0045 (0.0965)
0.1491 (0.1062)
0.0613 (0.0742)
0.0372 (0.0323)
 i2 0.0029 (0.0854) 0.1309 (0.0925) 0.0899 (0.0699)
0.0447 (0.0617)
 i3 0.054* (0.0282) 0.0619** (0.0304)
0.0108 (0.0296) 0.0479 (0.0590)
 i4 0.0108 (0.0324) 0.0106 (0.0347) 0.4257*** (0.0253) 0.0314 (0.0253)
ai1 0.1855*** (0.0297) 0.4590*** (0.0482) 0.0809* (0.0481) 0.0212 (0.0426)
ai2 0.0518*** (0.0087)
0.1222*** (0.0358)
0.0433* (0.0227)
0.0056 (0.0183)
ai3
0.0494* (0.0285)
0.0347 (0.0339) 0.1427*** (0.0301)
0.0156 (0.0253)
ai4 0.0008 (0.0352) 0.0034 (0.0388) 0.0079 (0.0297)
0.0081 (0.0418)
gi1 0.9679*** (0.1422) 0.3332** (0.1655) 0.0018 (0.0960)
0.1180 (0.0890)
gi2
0.0529 (0.1459) 0.5723*** (0.1672)
0.0111 (0.0994) 0.1124 (0.0925)
gi3 0.0188* (0.0114) 0.028* (0.0151) 0.9665*** (0.0077)
0.0130 (0.0082)
gi4
0.0166 (0.0105)
0.02316 (0.0149) 0.0104 (0.0077) 0.9653*** (0.0070)
di1
0.6179*** (0.0845)
0.6462*** (0.1185)
0.1226 (0.0788) 0.0198 (0.0730)
di2 0.3114*** (0.0977) 0.4628*** (0.1210) 0.1176 (0.0717)
0.0627 (0.0698)
di3 0.0537 (0.0453) 0.0386 (0.0507) 0.2316*** (0.0281) 0.0373 (0.0279)
di4 0.0369 (0.0493) 0.0369 (0.0623)
0.0689** (0.0305) 0.3431*** (0.0423)
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LB-Q(12) 14.081 11.021 9.727 16.830

Probability 0.296 0.527 0.640 0.156
LB-Q(24) 24.923 26.356 19.807 26.211
Probability 0.41 0.335 0.708 0.343
LB-Qs(12) 3.7576 4.475 4.44 17.805
Probability 0.988 0.973 0.974 0.122
LB-Qs(24) 8.3534 11.208 15.4 31.43
Probability 0.999 0.987 0.909 0.142
LLR 17583.26
AIC
26.03357
SC
25.73104

Notes: Constants are omitted in the above table to save space. Values in brackets are standard errors. ***, ** and * represent
the levels of significance of 1%, 5% and 10% respectively. LB-Q(12) and (24) stand for the Ljung–Box Q-statistic for the
standardised residuals up to 12 and 24 lags while LB-Qs(12) and (24) for the Ljung–Box Q-statistic for the squared
standardised residuals. LLR, AIC and SC represent the lag likelihood ratio, Akaike information criterion and Schwarz
criterion, respectively.

Table 3. Restriction tests concerning the four-variable asymmetric GARCH model

Log-likelihood ratio Degree of freedom
Asymmetric four-variable versus 3148.4077 284
asymmetric univariate model
H0: aijaji ¼ gijgji ¼ dijdji ¼ 0, i 6¼ j
The lagged returns of the Hang Seng 450.54 3
and S&P 500 indices do not belong to the model.
H0:  13 ¼  23 ¼  34 ¼ 0
Four-variable asymmetric model versus the model 276.12 12
without cross market effects between the
US and any other market
H0:  i4 ¼  4i ¼ ai4 ¼ a4i ¼ gi4 ¼ gi4 ¼ di4 ¼ d4i ¼ 0, i 6¼ 4
Four-variable asymmetric versus four-variable 419.28 10
symmetric model
H0: D ¼ 0
 292
we can reject the null hypothesis that conditional
variances of the four returns series are independent.7
We should model the four series simultaneously.
Now we begin to discuss the results estimated by
the four-variable asymmetric GARCH model as
presented in Table 2. We firstly look at matrix in
the mean equation, Equation 1, in order to see the
relationship in terms of returns across the four
indices. Note that the Ljung–Box Q statistics for the
12th and 24th orders in the standardized residuals
indicate the appropriate specification of the mean
equations. The own return linkages, as captured by
the diagonal parameters  11,  22,  33 and  44, are
statistically insignificant, suggesting that the returns
of the four indices do not depend on their first lags.
The cross-market return linkages are evident in the
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following patterns. There are unidirectional return
linkages between the stock exchange in Hong Kong
and those in mainland China, respectively, and
between the stock exchange of Hong Kong and the
US market. The evidence is that the off-diagonal
parameters,  13,  23 and  34, are significant while
their counterparts,  31,  32 and  43, are statistically
insignificant. Specifically, there are unidirectional
return spillovers from the US stock market to the
stock exchange in Hong Kong and from the stock
exchange in Hong Kong to those in Shanghai and in
Shenzhen, respectively. These unidirectional return
spillovers are confirmed by the log-likelihood ratio
test, presented in Table 3, for the restrictions
that  13 ¼  23 ¼  34 ¼ 0. As we can reject the null
hypothesis that the lagged returns of the Hang Seng
and S&P 500 indices do not belong to the model, we
conclude as follows. The returns of the Hang Seng
index (Granger) cause the returns of the Shanghai
and the Shenzhen indices, respectively, while the
returns of the S&P 500 (Granger) cause the returns of
the Hang Seng index. It seems that our results
support the conventional expectation that returns
spill over from a developed market to a less developed
or developing market. Moreover, given the evidence
of unidirectional return spillover from Hong Kong to
the mainland China, we can say that the Shanghai
and Shenzhen stock exchanges are linked to the stock
exchange in Hong Kong in terms of returns.
However, the magnitude of the linkage is small, as
a 1% increase in the returns of the Hang Seng index
will lead to 0.05% and 0.06% increase in the returns
of the two mainland Chinese indices, respectively.
Since we found two separate return linkages across
the four markets under study, it is of interest to
7
This hypothesis requires that all the cross products of the diagonal parameters are zero, i.e., aijaji ¼ gijgji ¼ dijdji ¼ 0 and i 6¼ j.
The cross products are the coefficients in the six covariance equations.
H. Li
investigate if there is any connection between the two
return linkages. That is, if the return linkages between
the stock exchange in Hong Kong and those in
mainland China have anything to do with the return
linkage between the Hang Seng index and the S&P
500 index. We impose the restrictions that the cross-
market effects between the S&P 500 index and any of
the other three indices are zero to omit the role of the
S&P 500 index in the four-variable GARCH model.
The results from this restricted four-variable asym-
metric GARCH model are reported in Table 4. On
the one hand, the statistic, 276.12 as reported in
Table 3, from the log-likelihood ratio test for the
restrictions that  i4 ¼  4i ¼ ai4 ¼ a4i ¼ gi4 ¼ gi4 ¼ di4 ¼
d4i ¼ 0 and i 6¼ 4 indicates that we can reject the null
hypothesis that the role of the US market should be
omitted in the model. We are assured that the original
unrestricted four-variable asymmetric GARCH
model is more appropriate than the restricted four-
variable asymmetric GARCH model. On the other
hand, we notice that the return spillovers from the
stock exchange in Hong Kong to those in mainland
China observed in Table 2 disappear in the model
restricting the role of the US market, according to the
results in Table 4. That is, once the return linkage
between the US market and the stock exchange in
Hong Kong is assumed to be nonexistent, the return
linkages between the stock exchange in Hong Kong
and those in mainland China disappear. This leads us
to conclude that the return linkages between the stock
exchange in Hong Kong and those in mainland China
have something to do with the linkage between the
Hang Seng index and the S&P 500 index. The stock
exchange of Hong Kong has acted as a go-between in
the information flow. The information about the
regional and global economic conditions is trans-
mitted into the pricing process of the mainland
Chinese stock exchanges through Hong Kong.
Furthermore, as we do not find any evidence of
return linkages between the stock exchanges in
Shanghai and Shenzhen, the information about the
domestic economic conditions does not play any role
in the pricing process of the Chinese stock exchanges.
Our results regarding returns are consistent with the
‘global centre’ hypothesis that a global centre such as
the US market plays a major role in the transmission
of news that is macroeconomic in nature.
Now we examine the estimated results for the time-
varying variance–covariance Equation 3 in the system.
Note that the Ljung–Box Q statistics for the12th and
24th orders in squared standardized residuals show
 International linkages of the Chinese stock exchanges 293
Table 4. Estimated coefficients for the restricted four-variable asymmetric GARCH Model

Shanghai (i ¼ 1) Shenzhen (i ¼ 2) Hang Seng (i ¼ 3) S&P 500 (i ¼ 4)

 i1 0.0069 (0.0903)
0.1400 (0.0922)
0.0614 (0.0825)
 i2 0.0355 (0.0835) 0.1590 (0.0843) 0.0459 (0.0776)
 i3 0.0411 (0.027) 0.0451 (0.0278) 0.0512 (0.0325)
 i4
0.1163 (0.0324)
ai1 0.3075*** (0.0372)
0.0748*** (0.0071)
0.0228*** (0.0082)
ai2
0.4243*** (0.0365)
0.0822*** (0.0151) 0.0001 (0.0047)
ai3 0.0418 (0.0275) 0.0515** (0.0246) 0.0960*** (0.0317)
ai4
0.1041*** (0.0350)
gi1 0.3978*** (0.1579)
0.0241 (0.1324) 0.1036 (0.0831)
gi2 0.5054*** (0.1465) 0.9781*** (0.1202)
0.0897 (0.0734)
gi3
0.0151 (0.0107)
0.0047 (0.0068) 0.9809*** (0.0048)
gi4 0.9644*** (0.0054)
di1
0.5419*** (0.0881)
0.3033*** (0.0609) 0.0751 (0.0831)
di2 0.182** (0.0855)
0.0205 (0.0490)
0.0483 (0.0776)
di3 0.0353 (0.0430) 0.0223 (0.0344)
0.2221*** (0.0281)
di4
0.3202*** (0.0423)
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LLR 17445.20
AIC
25.9377
SC
25.7282
Note: See Table 2.

that there is no series dependence in the squared
standardized residuals, indicating the appropriateness
of the fitted variance–covariance equations by the
four-variable asymmetric BEKK model. The condi-
tional variances for the four return series estimated by
the model are presented in Fig. 3. The matrices A and
G reported in Table 2 help examine the relationship in
terms of volatility as stated in Equation 3. The
diagonal elements in matrix A capture the own
ARCH effect, while the diagonal elements in matrix
G measure the own GARCH effect. As shown in
Table 2, the estimated diagonal parameters, except a44,
are all significant, indicating a strong GARCH (1,1)
process driving the conditional variances of the three
Chinese indices. Own past shocks and volatility affect
the conditional variance of the Shanghai composite,
Shenzhen component and Hang Seng indices while
own past volatility affects the conditional variance of
the S&P 500 index. The sum of the coefficients on
GARCH effect in each variance equation will measure
the volatility persistence for each series. As the sums of
the coefficients on the GARCH effect are 0.9172,
0.9104, 0.9781 and 0.9466, respectively, for the
Shanghai, Shenzhen, Hong Kong and the US markets,
there is a high degree of volatility persistence for all
four indices. The volatility persistence is lowest for the
Shanghai composite and the Shenzhen component
indices, indicating that the mainland Chinese share
price indices derive relatively less of their volatility
persistence from past volatility than the developed
markets. Past shocks have played a greater role in the
volatility of the mainland Chinese indices than in the
volatility of the Hang Seng index and the S&P
500 index.
The off-diagonal elements of matrix A and G
capture the cross-market effects such as shock spill-
over and volatility spillover among the four stock
exchanges. We find evidence of bidirectional
shock spillover between the two mainland Chinese
stock exchanges as the matching off-diagonal param-
eters, a12 and a21, are significant. News about shocks
of a mainland stock exchange affects the volatility of
the other mainland stock exchange. This two-way
shock spillover between the Shanghai and Shenzhen
stock exchanges indicates a strong connection, even
though dual listing is not allowed, between the two
markets. On the other hand, the bidirectional shock
spillover may be the evidence for the claim made by
Kim and Shin (2000) that Chinese domestic investors,
most of them are individual and non institutional,
tend to follow ‘herd behaviour’ due to their
inexperience or lack of skill to make systematic
decisions in share trading. In addition, the past
volatility of the Shanghai composite index affects the
conditional variance of the Shenzhen component
index, but not the other way round.
Moreover, we find evidence of volatility linkages
between the stock exchange in Hong Kong and those
in mainland China. First, there is bidirectional shock
spillover between the stock exchanges in Shanghai
and Hong Kong as the matching off-diagonal
parameters, a13 and a31, are significant. Given the
size of the mainland Chinese economy relative to that
of Hong Kong and close relationship in trade and
 294 H. Li
Shanghai Shenzhen
0.0012 0.0016

0.0010
0.0012
0.0008

0.0006 0.0008

0.0004
0.0004
0.0002

0.0000 0.0000
2000 2001 2002 2003 2004 2000 2001 2002 2003 2004

Hang Seng S&P 500

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0.0012 0.0008

0.0007
0.0010
0.0006
0.0008
0.0005

0.0006 0.0004

0.0003
0.0004
0.0002
0.0002
0.0001

0.0000 0.0000
2000 2001 2002 2003 2004 2000 2001 2002 2003 2004
Fig. 3. Conditional variances estimated by the four-variable asymmetric GARCH model

direct investment between Hong Kong and mainland
China, it should not be surprising that the news about
shocks in mainland China (a31 and a32) affects the
volatility of the Hang Seng index. Secondly, there is a
unidirectional volatility spillover from the Hong
Kong stock exchange to those in Shanghai and
Shenzhen, respectively. The evidence is that the
off-diagonal parameters, g13 and g23, are significant
while their counterparts, g31 and g32, are insignificant.
The past volatility of the Hang Seng index affects the
conditional variances of the Shanghai composite and
the Shenzhen component indices. However, the
magnitude of the squared coefficients between the
Hang Seng index and the mainland Chinese indices,
a13, a31, a32, g13 and g23, is very small, suggesting that
the extent of the volatility linkages between the stock
exchange in Hong Kong and those in mainland China
is weak.
Now we look at the role of the US market in terms
of volatility. Although it is not affected by the size
of the past shocks and past volatility of the US market,
the volatility of the Hang Seng index is influenced by
the sign of the shocks of the US market. The volatility
of the Hang Seng index increases more in response to
the negative shocks (bad news) about the S&P 500
index, as the off-diagonal parameter in matrix D, d34,
is significant. Is the volatility linkage between the US
market and the stock exchange in Hong Kong as
influential as the return linkage between them in the
information flow? As the volatility linkages (a12, a21,
a23, a31 and g12) among the indices of the Shanghai,
Shenzhen and Hong Kong stock exchanges are still
evident in Table 4 of the four-variable asymmetric
model restricting the role of the US market, we
conclude that the volatility linkages between the stock
exchanges in Hong Kong and mainland China have
nothing to do with the asymmetric response (d34) of
the Hang Seng index to the S&P 500 index. The
information about local and regional risk affects the
volatility of the Chinese share price indices directly.
This finding is consistent with the ‘home bias’
hypothesis that information about risk in the domestic
 International linkages of the Chinese stock exchanges
stock markets, as opposed to that about global
financial centre (the US market in this case), plays a
dominant role in the information transmission.
As far as matrix D is concerned, we find evidence
of asymmetric response to negative shocks (bad news)
of own market for all four share price indices under
study, as the diagonal parameters, d11, d22, d33 and
d44, are all significant. The sign of the own past
shocks affects the conditional variance of each index.
Moreover, the cross-market asymmetric response is
evident between the Shenzhen component index and
the Shanghai composite index. Volatility in the
Shenzhen stock exchange following a negative shock
in the Shanghai stock exchange is larger than that
following a positive shock in the Shanghai stock
exchange, and visa versa. The results about the
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asymmetric responses in the mainland Chinese indices
contradict Yeh and Lee (2000). Their study do not
find any evidence of asymmetric response to negative
shocks in mainland China and attribute the investor
behaviour there as chasing good news. However, our
results are supported by the following log-likelihood
test. As reported in Table 3, the statistic from the log-
likelihood test for the four-variable asymmetric
GARCH model vs. the four-variable symmetric
GARCH model is 419.28, suggesting that we can
reject the null hypothesis that the elements in matrix
D are zero simultaneously. Thus it is valid to include
the asymmetric responses when modelling the
Chinese stock exchanges.
Finally, we summarize the estimated results as
follows. Although they are not directly linked to
the US market, the mainland Chinese stock
exchanges are linked in terms of returns and
volatility to the developed market in Hong Kong.
However, the magnitude of the linkages is very
small. The low degree of linkages is supported by
the conditional co-variances estimated by the four-
variable asymmetric GARCH model, presented in
Fig. 4. The estimated conditional co-variances
suggest that there is no interaction between the
US market and either of the mainland Chinese
stock exchanges. The interactions between the
mainland stock exchanges and that in Hong
Kong are rather limited too.
The above conditional covariances show an
outlier around the 11 September 2001, indicating
the effects of the shock across the markets. In
order to provide a check on the robustness of the
results obtained in this study, we re-estimate the
model by using the data during 4 January 2002
and 17 January 2005, which avoids the data point
of the 11 September 2001. Using this restricted
sample, the four-variable asymmetric GARCH
model converges after 96 iterations and its results
295
are presented in Table 5. Although there is no
evidence of the return spillovers between either of
the Chinese stock exchanges and the Hong Kong
stock exchange, there are still uni-directional
volatility spillovers from the developed market in
Hong Kong to the mainland Chinese
stock exchanges. The magnitude of the volatility
linkages, g13 ¼ 0.072 and g23 ¼ 0.073, is greater
than that of g13 ¼ 0.019 and g23 ¼ 0.028 obtained
in the earlier sample. In common with the earlier
results, there are unidirectional returns and vola-
tility spillovers from the US market to the Hong
Kong stock exchange.
V. Conclusions
Using the share price indices from the stock exchanges
in Shanghai, Shenzhen, Hong Kong and the United
States, we have found some important international
linkages of the Chinese stock exchanges. The main-
land Chinese stock exchanges are linked in terms of
returns and volatility with the regional developed
market in Hong Kong while there is no direct linkage
between the mainland Chinese stock exchanges and
the global financial centre in the US. First, there is a
unidirectional return spillover from Hong Kong to the
mainland Chinese stock exchanges according to the
estimation using the whole sample. The information
about regional economic conditions is important in
the pricing process of the mainland Chinese share
price indices. As the return linkages between the stock
exchange in Hong Kong and those in mainland China
depend on the return linkage between the stock
exchange in Hong Kong and the US market, Hong
Kong has acted as a go-between in the information
flow. The information about global economic condi-
tions is transmitted into mainland China through
Hong Kong. Secondly, both the whole sample and the
restricted sample support that there are volatility
spillovers from the stock exchange in Hong Kong to
those in Shanghai and Shenzhen. As the volatility
linkages between the stock exchanges in Hong Kong
and the mainland China have nothing to do with
the asymmetric response of the Hang Seng index
to the S&P 500 index, the information about the risk
in the domestic and regional markets, as opposed to
that about the global financial centre, is important for
the volatility of the Chinese share price indices.
We conclude that the mainland Chinese stock
exchanges are integrated with the regional developed
stock exchange in Hong Kong. However, the small
magnitude of the coefficients of lagged returns of
Hang Seng index and that of the squared coefficients
 296 H. Li
Shanghai & Shenzhen Shanghai & Hang Seng
0.0014 0.0004

0.0012
0.0003
0.0010

0.0008 0.0002

0.0006 0.0001
0.0004
0.0000
0.0002

0.0000 −0.0001
2000 2001 2002 2003 2004 2000 2001 2002 2003 2004

Shanghai & S&P 500 Shenzhen & Hang Seng

0.00016 0.0006
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0.00012 0.0005

0.0004
0.00008
0.0003
0.00004
0.0002
0.00000
0.0001
−0.00004 0.0000

−0.00008 −0.0001
2000 2001 2002 2003 2004 2000 2001 2002 2003 2004

Shenzhen & S&P 500 Hang Seng & S&P 500

0.0003 0.0005

0.0004
0.0002
0.0003

0.0001 0.0002

0.0001
0.0000
0.0000

−0.0001 −0.0001
2000 2001 2002 2003 2004 2000 2001 2002 2003 2004

Fig. 4. Conditional covariances estimated by the four-variable asymmetric GARCH model

in the variance–covariance equations between the
mainland Chinese indices and the Hang Seng index
suggest that the extent of the linkages between the
stock exchange in Hong Kong and those in mainland
China is weak. The implication of the low level of the
linkages is that expected returns of the investment in
the Chinese mainland stock exchanges would be
determined mainly by the country’s exposure to firm-
specific and country-specific risk factors. The news
about overseas risk is not transmitted to the mainland
stock exchanges fully, suggesting potential benefits of
the reduction in the diversified risk for overseas
investors by adding the emerging Chinese stocks to
their international portfolio.
It is also evident that there is a bidirectional shock
spillover between the two Chinese mainland stock
exchanges. These two mainland stock exchanges are
integrated in terms of volatility although there are
some restrictions on the dual listings. The informa-
tion about risk within the country is important for the
 International linkages of the Chinese stock exchanges 297
Table 5. Estimated coefficients for the four-variable asymmetric GARCH model using the sample from 4 January 2002
to 17 August 2005
Shanghai (i ¼ 1) Shenzhen (i ¼ 2) Hang Seng (i ¼ 3) S&P 500 (i ¼ 4)
 i1
0.0645 (0.1186)
0.1196 (0.1245) 0.0081 (0.0810)
0.0316 (0.0692)
 i2 0.0513 (0.1160) 0.1002 (0.1220) 0.0316 (0.0773) 0.0226 (0.0675)
 i3 0.0620 (0.0495) 0.0591 (0.0520)
0.0011 (0.0395) 0.0304 (0.0375)
 i4 0.0107 (0.0488) 0.0097 (0.0521) 0.3461*** (0.0312)
0.0883 (0.0426)
ai1 0.4011*** (0.0405) 0.2383*** (0.0414) 0.0290 (0.0308) 0.0117 (0.0240)
ai2
0.1028*** (0.0204) 0.0597*** (0.0074) 0.0055 (0.0089) 0.0021 (0.0069)
ai3
0.0121 (0.0800)
0.0236 (0.0852)
0.1106*** (0.0116)
0.0222 (0.0420)
ai4
0.0604 (0.0674)
0.0624 (0.0702) 0.0432 (0.0346) 0.0409 (0.0435)
gi1 0.9713*** (0.0620)
0.0058 (0.0630)
0.0213 (0.0207)
0.0031 (0.0213)
gi2
0.1030 (0.0741) 0.8735*** (0.0749) 0.0027 (0.0328)
0.0026 (0.0291)
gi3 0.0723* (0.0433) 0.0726* (0.0437) 0.9661*** (0.0189) 0.0004 (0.0180)
gi4
0.0220 (0.0198)
0.0211 (0.0201) 0.0161** (0.0080) 0.9786*** (0.0078)
di1 0.0067 (0.1973)
0.0674 (0.1936) 0.0584 (0.1169)
0.0148 (0.0856)
di2
0.3673*** (0.1413)
0.3001** (0.1372)
0.0456 (0.1130)
0.0111 (0.0824)
di3 0.0658 (0.1083) 0.0297 (0.1123)
0.1707*** (0.0404)
0.0876* (0.0485)
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di4 0.1016 (0.0813) 0.1094 (0.0855)
0.0081 (0.0336) 0.2953*** (0.0395)

LLR 11095.17
AIC
26.87115
SC
26.42319
Note: See Table 2.

volatility of the mainland share price indices. This
study also confirms that there is an asymmetric
response of volatility in all four stock exchanges
under study. The conditional variance of each index
is affected not only by the size of shocks but also the
sign of the shocks of its own market. There are cross-
market asymmetric responses between the two stock
exchanges in mainland China in addition.
Acknowledgements
The author is grateful for helpful discussions
and comments from Paul Auerbach, Vince Daly,
Subrata Ghatak and Willy Spanjers. Any remaining
errors are the author’s responsibility.
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