Introduction

Building an integrated capital market in East Asia remains very much a work in progress. In banking and fixed income markets, the integration that characterizes the United States (US) dollar markets can be found only in pockets of the local currency markets. The yen bond market has come to serve as no more than a niche source of funding for a few of the best credits in East Asia outside Japan. One of the strongest links in the region joins bond investors in Japan to firms in Australia and households in New Zealand. With exceptions, equity markets in the region share much of their price movement. This, however, reflects less a regional bid than their common integration with major global markets through imitation and common capital flows.

This review takes stock of integration in the debt and equity capital markets by examining evidence on both flows of transactions and stocks of asset holdings as well as evidence on pricing. Unlike most recent studies of the subject, this review does not rely on the stock holdings of East Asian debt by East Asians.¹ To rely on such evidence makes it impossible to distinguish the well-integrated foreign currency bond market from the very domestic currency markets. Instead, evidence from the primary market for foreign currency bonds is consulted. For a different reason, the Bank for International Settlements (BIS) data on international banking are not used as the primary source for measuring the integration of East Asian banking markets. In this case, it is the very partial coverage of BIS reporting economies in the region that argues for another approach. Again, data from the primary market, this time for internationally syndicated loans, are consulted.

It should be clear at the outset what this review does not attempt. While the relationships among short-term interest rates in the region represent an important aspect of financial market integration (De Brouwer, 1999; Cheung et al., 2003), the short end of the yield curve lies outside this review's scope. Similarly, the relationships among exchange rates in the region, which show waning stability against the US dollar and waxing stability against trade- weighted baskets, and between onshore and offshore exchange rates (Ma et al., 2004; Ho et al., 2005; Cairns et al., 2007) lie outside this review's scope. The growing body of work on the relationship between financial integration and the responsiveness of consumption to domestic output is also not addressed (Mercereau, 2005; Kim, Kim, and Wang, 2006; Kim, Lee, and Shin, 2006). Finally, policy questions like those addressed by Kuroda (2003) and Kuroda and Kawai (2003) are not systematically addressed, though there is some analysis of the response of market participants to the Asian Bond Fund initiative.

This stock-taking essay approaches regional financial integration in the capital markets of East Asia by examining first the fixed income markets and then the equity markets. The section below measures the substantial regional integration evident in the US dollar markets for international bonds and syndicated credits. This integration then provides a contrast to the generally insular domestic currency bond markets in the region. Finally, the considerable co-movement in equity prices is interpreted not as a sign of regional integration but rather is ascribed to the common response to common capital flows emanating from shifts in the behavior of global asset managers.

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