RESEARCH CONFERENCE ONSAFETY AND EFFICIENCY OF THE FINANCIAL SYSTEM

27th AUGUST 2007

ASIA-LINK PROGRAMMEEuro-Philippines Network in Banking & FinanceEnhancing Teaching and ResearchAsialink/ASIE/B7-3010/2005/105-139

WORLD BUSINESS CYCLE, LOCAL SPECIALIZATION

AND ASSET PRICES

Noëlle DUPORTDaniel GOYEAUGenelyn Ma. SARTE

Two approaches:

-The “country approach”: hypothesis of non perfect integration of the national economies

-The “sectoral approach”: hypothesis of non perfect synchronization of the different industries during the worldwide activity cycle.

The common hypothesis of these two approaches: the financial cycle depends on the business cycle

Aim of this paper: to study what can be the contribution of several south-east and central Asian countries in a logic of international portfolio diversification?

Origins of the benefits from international portfolio diversification:

Methodology Used to Address the Objective of the Study

3 steps:- fit a univariate Markov-switching autoregressive (MSAR) model with two regimes to each series

MSM(H)

MSI(H)

).,(~ )(20 mt IID

tptpttmt yyyy ...2211

).,(~ )(20 mt IID

tptptptttttt SySySySy )(...)()()( 222111

Methodology Used to Address the Objective of the Study

- compute the degree of concordance (Harding and Pagan, 2002)between cycles of two series

modified degree of concordance

00111

rtjtrtjtjr SSSST

I ,#,#

Tt ,...,,21

00111

rthtjrthtjhjr SSSS

nI ,#,# ,,

Methodology Used in to Address the Objective of the Study

- perform the robust test for strong non-synchronization (Harding and Pagan, 2006)

tests for the hypothesis between two regime variables with correction for serial correlation and heteroscedasticity

analysis includes cases where h=0, h<0, and h>0

0S

The concordance between business and financial cycles of each country

Reference: Financial Cycle

Country

h=0 highest t-stat (in absolute value)

Concordance t-stat Concordance t-stat lag (h)

US 0.837 4.142 0.837 4.614 3

Indonesia 0.475 -1.071 0.479 -0.929 -1

Korea 0.434 -0.363 0.492 1.480 -5

Malaysia 0.254 -1.032 0.303 1.693 -3

Philippines 0.500 0.133 0.510 0.272 6

Singapore 0.541 -0.851 0.622 2.004 -6

Thailand 0.549 1.221 0.555 1.464 -6

The concordance between business and financial cycles of each country

US Emerging countries

Business cycle

Financial cycle

Business cycle

Financial cycle

Leading by 3 months

No link (except for Singapore)

The financial markets of the emerging countries are not driven by their own real conditions. Are they driven by the worldwide cycle (financial and/or business)?

Are they driven by the worldwide financial cycle?

The concordance between financial cycles of the US and emerging countries

Reference: US Financial Cycle

Country

h=0 highest t-stat (in absolute value)

Concordance t-stat Concordance t-stat lag (h)

Indonesia 0.769 3.267 0.765 3.317 -2

Korea 0.520 0.702 0.424 -0.766 6

Malaysia 0.720 0.320 0.689 -0.365 -6

Philippines 0.773 4.046 0.765 4.122 -4

Singapore 0.690 2.132 0.680 2.248 -4

Thailand 0.603 -2.209 0.587 -3.156 5 & 6

The concordance between financial cycles of the US and emerging countries

3 cases:

Indonesia, Philippines and Singapore:

These financial markets are leading the worldwide financial cycle

Korea and Malaysia:

These financial markets have no significant concordance with the worldwide financial cycle

Thailand:

This financial market is lagging the worldwide financial cycle, and is counter-cyclical

Are they driven by the worldwide financial cycle?

YES NO YES

Are they driven by the worldwide business cycle?

The concordance between financial cycle of emerging countries and the business cycle of the US

Reference: US Business Cycle

Country

h=0 highest t-stat (in absolute value)

Concordance t-stat Concordance t-stat lag (h)

Indonesia 0.681 1.738 0.702 2.433 -5

Korea 0.480 0.500 0.513 1.481 -4

Malaysia 0.797 0.296 0.773 -0.615 6

Philippines 0.632 2.123 0.623 2.144 -3

Singapore 0.569 0.340 0.650 1.490 5

Thailand 0.683 -2.516 0.691 -2.517 1

The concordance between financial cycle of emerging countries and the business cycle of the US

3 cases:

Indonesia, Philippines:

These financial markets are leading the worldwide business cycle

Korea, Malaysia and Singapore:

These financial markets have no significant concordance with the worldwide business cycle

Thailand:

This financial market is lagging the worldwide business cycle, and is counter-cyclical

Are they driven by the worldwide business cycle?

YES NO YES

Conclusion in terms of international portfolio diversification:

Indonesia

Philippines

Singapore

-The financial markets do not depend on the local real conditions (or

very slightly for Singapore)

- but on the other hand depend on the worldwide financial market.

- However this dependence does not remove all their interest in

diversification term insofar as they present a significant lead

compared to the US financial market. In this case, the investor can

apply a geographical strategy of rotation

Conclusion in terms of international portfolio diversification:

Korea

Malaysia

- The financial markets do not depend on the local real conditions

- and they do not depend on the worldwide financial market.

- the investor can use these financial markets to apply a strategy

of diversification in purely speculative matter

Conclusion in terms of international portfolio diversification:

Thailand

-The financial market does not depend on the local real conditions

- but on the other hand depends on the worldwide financial market,

in a counter-cyclical way.

-In this case, the investor can use this market in a simple logic of

diversification.

Maraming Salamat!Maraming Salamat!