Financial Markets Open, Integrated And Micro-effects

In the first place, it is difficult to assess how open or closed a country's financial system actually to be. This dissertation studies the measurement approach based on the clearly defined concept of "financial market integration". The effect of the process on the asset pricing and allocation, portfolio choice, the intertemporal consumption behavior and welfare implications are derived and analyzed. Empirical tests are presented for major markets in East Asia, using 1993-2003 monthly data to estimate the degree of money markets' integrating into the world market. As a complementary illustration, domestic financial integration is also examined to reflect the financial market developments. Finally, the intertemporal consumption smoothing effect—an important but seldom explored issue-is empirically studied in East Asia from 1981 to 2004.The whole dissertation can be divided into four parts and consists of seven chapters:Section 1, namely, chapter one is the introduction of this dissertation. it raises the main questions that will be studied in this paper, summarizes the outlines, the analyzing methods and concepts specified in the following discussion. The main contribution in this study is also summed up.Section 2, including chapter two and three, is the theoretic analysis part. Chapter two considers various methods to empirically test for financial integration in a unified framework. In addition to the conventional test of the common price of risk, the new approaches based on the stochastic discount factor are also explored. In chapter three, we study the effect of financial market integration on assets price and allocation, portfolio choice and intertemporal consumption smoothing, with the different hypothesis of risk-free interest rate determinations. The welfare implications are followed. Notably, we find that a country's welfare may decrease significantly on market integration, specifically for countries that are smoothing consumption forward, or are borrowing against future wealth in the international bond market. This point should be treated with caution since those are fractional measures of welfare changes.Section 3 is the positive analysis in East Asia. Three Chapters of empirical analyses can be summarized into two parts: the previous part is chapter four and chapter five. In Chapter four, Empirical tests using the time-series data in EastAsia and US money markets from 1993-2003 reveal that convergence tendency is found in the money market. While most indicators suggest that progress in financial integration has so far been modest and is still far from being complete. Firstly, the evidence favours the view that markets are increasingly integrated and assets increasingly substitutable as controls have been eased. We introduce the decomposition method of Frankel and MacArthur(1988) to study the average ex post real interest differentials. Deviations from Uncovered Interest rate Parity account much for the deviation from Real Interest rate Parity in Indonesia, Korea, Philippines and Thailand, While in Hong Kong deviations from relative Purchasing-Power Parity is the main cause. Secondly, by using VAR variance decomposition, we prove that domestic economy can't be immune from the foreign influence by capital controls. The proportion of innovations to the domestic interest rate caused by the foreign interest rate has increased over time in Hong Kong, Indonesia, Japan, Singapore, Philippines and Thailand. Thirdly, the weak trade-off between the degree and speed of Money market integration does exist in some economy. Moreover, equity markets of East Asia are gradually integrating into the world market, although they still need further development.Chapter five is a complementary demonstration to the previous results. Whether the integration of money markets does indeed signal broader, more fundamental financial integration—an issue unexamined in the literature of international financial integration—should be examined by focusing on the changing relationship between the money market interest rate and deposit and lending interest rate in each economy. Correlation coefficients and an error-correction model for money and institutional interest rate are presented to reveal there is an inherently long-term relationship between them. During the latter half of 1990s, the speed and pattern of adjustment in most of the developing/newly industrialized economies of East Asia has become similar to that in economies with developed financial system. Besides, the adjustment of deposit rates is more rapidly than loan rates.The latter part of empirical study is explored in Chapter six, mainly assessing the effect of international financial integration on private consumption smoothing in six selected economies in the East Asia. It outlines a simple model of consumer choice under liquidity constraints with changing real interest rates and demographics which motivates tests for a statistically significant effect on...