Equity Markets

Equity markets in East Asia are generally highly integrated into the global equity market. US and European investors bulk large among the foreign holders of East Asian equities (Table 4 [ PDF 89.7KB | 1 pages ]). Japanese investors have not been prominent. Other East Asian investors, mostly in Hong Kong and Singapore, hold about 10% of foreign-held East Asian shares.

It is interesting but not informative to learn that the regional integration of equity markets in Asia lags behind that of Europe (Lee, 2006). While the single currency had its most immediate and dramatic effect on cross-border bank flows as a euro-area-wide interbank market sprang into being, it also had an important effect on the construction of European equity portfolios. In the absence of currency risk, portfolio managers shifted from allocating by country and then by industry in Europe to simply allocating by industry (Tsatsaronis, 2001; Fratzscher, 2001; Adjaouté and Danthine, 2002). It is interesting but hardly surprising that Asia falls short of the capital market integration of post-euro Europe. It would be more informative to learn whether Asia falls short of the capital market integration of pre-euro Europe.

One important development in the past several years that has tightened capital market integration in the region is the outflow of Japanese savings into equity securities in the region. China and India have both been major recipients. At the end of 2006, the Japanese external assets included ¥2.4 trillion in Hong Kong-dollar-denominated equities, much of which can be assumed to be H shares of Chinese firms. This represents a substantial rise from the sum of ¥1.5 trillion in the previous year (and the less than ¥0.3 trillion shown on Table 4 for 2003).

A comparison of equity and local currency bond correlations with the US market gives evidence of the global integration of the Asian equity markets (Figure 6 [ PDF 70.3KB | 1 pages ]).¹⁴ Apart from Hong Kong and Singapore, the equity correlations are higher. The idiosyncratic political events during this period in Indonesia and the Philippines did not prevent moderate correlations between the local stock markets and global stock markets. Neither did the limits on non- resident purchases of Indian equities keep their price changes from echoing global movements. Only China's A share market was as hermetic as its bond market.

Capital flows, mostly from outside the region, play a role in producing these correlations. Chai-anant and Ho (2007) confirm findings of earlier studies that non-residents generally buy into rising regional markets and sell into falling ones. They also find that inflows push up currencies and outflows push down currencies. Their further finding that net equity flows show strong co-movement across six Asian equity markets suggests that equity capital flows may subject Asian economies to common shocks, leading at times to common policy responses. If foreign investors chase returns in regional equity markets, and affect currency values in the process, some further thinking is required on the procyclical nature of the international risk sharing implied by the substantial global holdings of Asian equities. In a regional downturn, global investors may not accept their share of the poor harvest, as they do in a textbook, but instead may demand that regional markets provide the liquidity for their exit.

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