Equity Market Integration and Currency Risk: Empirical Evidence for Indonesia
AbstractThis paper tests the time-varying degree of Indonesian market integration using conditional version of the International Capital Asset Pricing Model (ICAPM) with applying a GDC-GARCH. The use of the GDC-GARCH technique allows us to first, describe the time-varying stochastic conditional covariance matrix and second, take into account the dynamic changes in the degree of market integration and risk premium. Our empirical results show clear evidence of market integration varying degree, explained by the U.S term premium and the level of market openness. Even though it reaches high values during turmoil periods, and exhibits an upward trend towards the end of the estimation period, Indonesian stock market still remain substantially segmented from the regional market. These results thus suggest that diversification into emerging market assets continues to produce substantial profits, and that the asset pricing rules should reflect a state of partial integration. Our investigation addresses the evolution and formation of total risk premiums and confirms this empirically. In fact, the total risk premium decomposition shows that the variance risk related to the local market index (the local risk factor), explains more than 50% of the total risk premium on average.
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Bibliographic InfoPaper provided by Department of Research, Ipag Business School in its series Working Papers with number 2014-096.
Length: 12 pages
Date of creation: 12 Feb 2014
Date of revision:
Time-varying integration; risk premium; ICAPM; GCC-GARCH;
Find related papers by JEL classification:
- C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
- F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
This paper has been announced in the following NEP Reports:
- NEP-ALL-2014-02-21 (All new papers)
- NEP-FMK-2014-02-21 (Financial Markets)
- NEP-IFN-2014-02-21 (International Finance)
- NEP-SEA-2014-02-21 (South East Asia)
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