Kian-Ping Lim, Hock-Ann Lee & Venus Khim-Sen Liew (eds.). 2006. Time Series Econometrics Analysis: Selected Issues in ASEAN Economies. 181 pages. Malaysia: Pearson. [ISBN: 983-3205-90-9].
Introduction:
This book entitled “Time Series Econometrics Analysis: Selected Issues in ASEAN Economies” is a collection of twelve articles on several contemporaneous economical and financial issues in the context of Association of South-East Asian Nations (ASEAN) economies. These articles, covering the aspects of exchange rates, stock markets, foreign direct investments, economic growths, inflations and trade balances, are contributed by eleven young academicians and researchers from various Malaysian universities. It is hoped that the empirical findings put forward by these authors upon modeling and estimating using the latest econometric procedures are illuminating to our efforts in promoting economic growths and financial developments in the individual member countries in specific as well as regional economic integration as a whole.
Under the waves of financial liberalization and globalization, it is instructive to enhance regional economic integration among developing countries in the interests of keeping with the orientations and avoiding international isolation. However, in the case of South East Asian economies, wide disparity among national outputs may hinder regional economic integration. The article titled “Income Convergence” by Hock-Ann Lee, Kian-Ping Lim and Associate Professor Dr. M. Azali empirically examines whether the income of Indonesia, Malaysia, the Philippines, Singapore and Thailand (collectively known as ASEAN-5 throughout this book) converge to that of Japan, the leader and benchmark country in the South East Asian region in terms of economic outputs. As only evidence of long run convergence between Singapore and Japan economies is found, the authors point out that in order to achieve greater economic integration among countries of South East Asia, there is an urgent need to narrow down the income gaps among these economies.
Unsustainable external imbalances may be hazardous to a nation’s economy. ASEAN-5 economies except Singapore experienced external imbalances in the late 1980s. The position persists until the outbreak of 1997 Asian Financial Crisis, one of the tsunami-shocks of financial liberalization waves that caused a sharp depreciation in the currencies of these economies (with the exception of Singapore dollar). Disregarding the fact that the crisis badly dampened the regions’ economic growths, it nonetheless had induced positive trade balances to these crisis-affected countries. Dr. Evan Lau tells us more on this issue in his article titled “Long Run Sustainability of External Imbalances”. The author reports, among others, that prior to the crisis, external imbalances are consistent with the intertemporal budget constraint in Malaysia and Singapore but not their neighbouring countries. Dr. Lau attributes these findings to the macroeconomic structural differences among these countries. He also shows that that large and persistent external imbalances can generally trigger a financial crisis. Thus, according to his study, external imbalances must be vigilantly managed to avoid another damaging financial crisis.
Economic prosperity of a region is always linked to massive inflows of foreign direct investments (FDIs). In the past two decades or so, the major economies in ASEAN region have received massive FDI due to the orientations of financial liberalization and globalization. Noticeably, during these years, these economies have recorded overwhelming economic growths. Looking onto this matter, Chee-Keong Choong, Associate Professor Dr. Zulkornain Yusop and Siew-Choo Soo in their article on “Foreign Direct Investment and Economic Growth”, exert that the pattern of relationship between FDI and economic growth in the ASEAN region differ according to the recipient country’s characteristics such as human capital, competitiveness, market size, as well as FDI and trade policies. They conclude that improving the conditions of domestic accumulation, technological capability and productivity efficiency in this region are crucial factors in attracting more FDI and henceforth stimulating economic growths.
Economic growth, from another point of view, is often related to inflation. In this regards, Venus Khim-Sen Liew, Kian-Ping Lim and Chin-Hong Puah in their article entitled “Output and Inflation” discover the negative relationship between these two macroeconomic variables. Particularly, high rates of inflation are associated with low real outputs and vice versa. Thus, in order to boost economic growths, it is important to maintain the current low level of inflation rates. Besides, their findings suggest that the new Keynesian model, which advocates government intervention in altering the economy business cycle, is more applicable in these economies. This implies that the governments rather than market free force should play an important role in achieving macroeconomic goals in ASEAN economies.
Turning to ASEAN as open economies, our concerns focus on exchange rate behaviour, which has been commonly associated with, among other implications, international trade competitiveness of a country. Focusing on this area, the article on “Exchange Rate, Real Money and Trade Balance Relationship” by Venus Khim-Sen Liew, Kian-Ping Lim and Huzaimi Hussain, analyses whether exchange rate has any significant and direct impact on trade balance. Through empirical investigation, the authors found that the role of exchange rate in initiating changes in the trade balances has been exaggerated in the case of ASEAN-5. They further show mathematically that it is real money rather than nominal exchange rate that will influence trade balance. Their proposition is empirically supported by the ASEAN-5 data. As such they suggest that in order to cope with trade deficits, the governments of these countries might resort to policy measures focusing on the real money variables.
Chee-Wooi Hooy looks at the implication of exchange rate from another perspective. His article entitled “Exchange Rate Volatility Spillover Effect” explains that exchange rate has great impact on regional economic integration. It is well-known that following the collapse of the Bretton Woods fixed exchange rate arrangement in March 1973, exchange rates of most the countries in the world including those in the ASEAN region are experiencing substantial fluctuation and at times excessive volatility. However, excessive exchange rates volatility inserts tremendous pressure on inter- and intra-regional trade competitiveness, hindering the objective of forming a free trade area in regional economies. Thus, according to Hooy, the understanding on how a group of regional currencies discount common shock and absorb increased volatility due to the fast pace of globalization and financial deregulation among emerging markets during the last two decades is of significant importance in ensuring persistent trade and monetary coordination subsist among member countries in the ASEAN region. His empirical results indicate that Japanese yen plays a dominant role in explaining the volatility system of the ASEAN-5 currencies, but not the pound sterling. On the other hand, Philippines peso and Thai baht behave exogeneously in the volatility system. Meanwhile both Indonesian rupiah and Malaysian ringgit have extensive exposure to their neighbouring currencies’ volatilities. Hooy’s findings, among others, also demonstrate the important role of Japan in influencing the economic development and structural changes of ASEAN-5, thereby providing the groundwork for the formation of yen bloc in this region.
Due to its importance to open economies, policy makers, foreign investors and other financial market players use to pay great attention to understand the exchange rate movement. One way to trace the exchange rate movement is from the purchasing power (PPP) perspective as the PPP postulates that in the long run, exchange rate and relative prices should move together. Surprisingly, in sharp contrast to PPP hypothesis, Kian-Ping Lim, Hock-Ann Lee and Evan Lau in their article titled “Cointegration Tests of Purchasing Power Parity” find no co-movement relationship between ASEAN-5 exchange rates no matter the numeraire currency is US dollar or Japanese yen, based on the conventional Johansen and Juselius cointegration test. Nonetheless, co-movement relationship is uncovered by Bierens’ non-parametric cointegration test, which does not require the assumption of linearity as in the former test and therefore the latter finding is more robust. Hence, they conclude that PPP actually holds in the case of ASEAN-5 exchange rates. The authors further observed that stronger evidence if PPP is provided by the yen-based rather than the dollar based exchange rates. This suggests that ASEAN countries are more closely linked with Japan than US in terms of economic activities, thereby providing another evidence, in conjunction with the study of Hooy, on the formation of yen bloc in this region.
Apart from the cointegration method, one may approach the testing of PPP hypothesis from the unit root perspective. However, in the past, both methods produce equally many mixed results, rendering the PPP a controversial and therefore hotly debated issue. In an attempt to reconcile the inconclusive evidence on PPP, the article on “Unit Roots of Purchasing Power Parity” written by Venus Khim-Sen Liew points out that the negligence of non-linearity may be the main cause of the contrasting findings in the literature. The author shows from the perspective of unit root tests that conventional tests, which are constructed in the linear frameworks have low power in the presence of non-linearity, thereby yielding misleading results. Having this setting in mind, then the apparently surprising contrasting results due to different methodologies (Johensen and Juselius cointegration test and Bierens’ non-parametric cointegration test) in the work of Kian-Ping Lim, Hock-Ann Lee and Evan Lau in the previous article may be explained by the failure of the former to account for nonlinearity, which has been shown presence in this region under study in the work of Kian-Ping Lim and Venus Khim-Sen Liew.
Besides the understanding the exchange rate movements, stock market behaviour is also of great interest to financial market participants. In particular, forecasting stock market movement is a crucial task in decision-making process for equity market investors. Venus Khim-Sen Liew, Kian-Ping Lim and Chee-Keong Choong demonstrate the usefulness of various most contemporary linear and non-linear time series models in this respect. They reveal in their article entitled “Forecasting the Stock Markets Returns” that both linear and non-linear time series models give better prediction than the random walk model, investors may yield profits by carefully designing their investment strategy based on properly selected time series models.
Of late, numerous studies in the scope of financial economics have discovered the presence of non-linearities in financial markets in developed countries. Out of inquisitiveness, Kian-Ping Lim and Venus Khim-Sen Liew examine the linearity nature of foreign exchange and stock markets in the ASEAN region. They find evidence of non-linear dependencies and STAR-type non-linearity in the exchange rate and stock market returns. Their findings, while lighting the fact that researchers cannot take the linear assumption as granted, also point to the need to test for non-linearity as a preliminary diagnostic tool to determine the nature of the data generating process before any further empirical analysis. Their article titled “Non-Linearity in Financial Markets” contains more details.
In a separate endeavor, Kian-Ping Lim in his article on the topic “Episodic Behaviour in Financial Markets” reveals that the non-linearity presents in the ASEAN financial markets is indeed episodic and transient in nature. This finding, which suggests that at times these markets are forecastable, while unpredictable at other times, may be taken as evidence to reconcile the controversy between the efficient market hypothesis and behavioral science.
In the later half of 1980s and early years of 1990s, most of the government of ASEAN countries gradually liberalized their stock markets, given investors the opportunity to invest in domestic securities. One question in mind is: Can investment risks within this region be diversified through distributing investment funds in various ASEAN stock markets? It is pointed out by Kian-Ping Lim, Hock-Ann Lee and Venus Khim-Sen Liew in their article titled “Stock Markets: International Diversification Benefits?” that in the long run there is no diversification benefit by doing so. The authors put forward that the strong economic ties in this region lead to co-movement in these stock markets, thereby making risk diversification not possible.
To wrap up this introduction chapter, some major implications of the above findings could be summarized as follows:
First, there is an urgent need to narrow down the output gap between Singapore and the rest of the countries in the ASEAN region to foster economic integration. In this regards, ASEAN governments that have been found more influential than market free force should work together to enhance regional economic growths via improving the conditions of domestic accumulation, technological capability and productivity efficiency in this region in their efforts to attract more foreign direct investment, whilst maintaining low level of inflation.
Second, the evidence of purchasing power parity in this region with regard to Japan and the findings of dominant role of yen in influencing the ASEAN exchange rates in this book in principle lend us support to the proposed formulation of yen bloc for the benefits of ASEAN in particular and Asian in general. Based on this groundwork, policy makers and academics researchers are encouraged to further explore for the means of achieving this goal.
Third, countries with large and persistent external imbalances due to trade deficits are vulnerable to potential currency attack. Hence, managing unsustainable trade deficits may help to safeguard a country from the unwanted disaster. To do improve trade deficits, policy measures should, among others, focus on the real money variables.
Fourth, ASEAN exchange rate and stock markets do not follow the drunken man’s random walk movements, as would the efficient market hypothesis suggest. These markets are found predictable by the carefully devised time series models. Nonetheless, one must be aware of the episodic behavior of these financial markets, which imply that one must understand the linearity nature of the dynamics of these markets to yield any reliable and profitable forecasts.
Fifth, as there are some evidences of stock markets linkage among the ASEAN countries due to close economies ties, equity market investors who are of course most welcomed to invest their funds here should seek for risk diversification in markets outside this region at the same time.
Finally, consistent with the findings elsewhere for developed countries, it has been shown that non-linearities are common characteristic of financial markets in this region. As such, researchers can no more safely take the linear assumption as granted. Instead, in the interests of soliciting robust empirical findings and rigid policy recommendations, testing of non-linearity should be the first and foremost exercise before any further empirical analysis in this field of work.
Venus Khim-Sen Liew
Kian-Ping Lim
Hock-Ann Lee
Under the waves of financial liberalization and globalization, it is instructive to enhance regional economic integration among developing countries in the interests of keeping with the orientations and avoiding international isolation. However, in the case of South East Asian economies, wide disparity among national outputs may hinder regional economic integration. The article titled “Income Convergence” by Hock-Ann Lee, Kian-Ping Lim and Associate Professor Dr. M. Azali empirically examines whether the income of Indonesia, Malaysia, the Philippines, Singapore and Thailand (collectively known as ASEAN-5 throughout this book) converge to that of Japan, the leader and benchmark country in the South East Asian region in terms of economic outputs. As only evidence of long run convergence between Singapore and Japan economies is found, the authors point out that in order to achieve greater economic integration among countries of South East Asia, there is an urgent need to narrow down the income gaps among these economies.
Unsustainable external imbalances may be hazardous to a nation’s economy. ASEAN-5 economies except Singapore experienced external imbalances in the late 1980s. The position persists until the outbreak of 1997 Asian Financial Crisis, one of the tsunami-shocks of financial liberalization waves that caused a sharp depreciation in the currencies of these economies (with the exception of Singapore dollar). Disregarding the fact that the crisis badly dampened the regions’ economic growths, it nonetheless had induced positive trade balances to these crisis-affected countries. Dr. Evan Lau tells us more on this issue in his article titled “Long Run Sustainability of External Imbalances”. The author reports, among others, that prior to the crisis, external imbalances are consistent with the intertemporal budget constraint in Malaysia and Singapore but not their neighbouring countries. Dr. Lau attributes these findings to the macroeconomic structural differences among these countries. He also shows that that large and persistent external imbalances can generally trigger a financial crisis. Thus, according to his study, external imbalances must be vigilantly managed to avoid another damaging financial crisis.
Economic prosperity of a region is always linked to massive inflows of foreign direct investments (FDIs). In the past two decades or so, the major economies in ASEAN region have received massive FDI due to the orientations of financial liberalization and globalization. Noticeably, during these years, these economies have recorded overwhelming economic growths. Looking onto this matter, Chee-Keong Choong, Associate Professor Dr. Zulkornain Yusop and Siew-Choo Soo in their article on “Foreign Direct Investment and Economic Growth”, exert that the pattern of relationship between FDI and economic growth in the ASEAN region differ according to the recipient country’s characteristics such as human capital, competitiveness, market size, as well as FDI and trade policies. They conclude that improving the conditions of domestic accumulation, technological capability and productivity efficiency in this region are crucial factors in attracting more FDI and henceforth stimulating economic growths.
Economic growth, from another point of view, is often related to inflation. In this regards, Venus Khim-Sen Liew, Kian-Ping Lim and Chin-Hong Puah in their article entitled “Output and Inflation” discover the negative relationship between these two macroeconomic variables. Particularly, high rates of inflation are associated with low real outputs and vice versa. Thus, in order to boost economic growths, it is important to maintain the current low level of inflation rates. Besides, their findings suggest that the new Keynesian model, which advocates government intervention in altering the economy business cycle, is more applicable in these economies. This implies that the governments rather than market free force should play an important role in achieving macroeconomic goals in ASEAN economies.
Turning to ASEAN as open economies, our concerns focus on exchange rate behaviour, which has been commonly associated with, among other implications, international trade competitiveness of a country. Focusing on this area, the article on “Exchange Rate, Real Money and Trade Balance Relationship” by Venus Khim-Sen Liew, Kian-Ping Lim and Huzaimi Hussain, analyses whether exchange rate has any significant and direct impact on trade balance. Through empirical investigation, the authors found that the role of exchange rate in initiating changes in the trade balances has been exaggerated in the case of ASEAN-5. They further show mathematically that it is real money rather than nominal exchange rate that will influence trade balance. Their proposition is empirically supported by the ASEAN-5 data. As such they suggest that in order to cope with trade deficits, the governments of these countries might resort to policy measures focusing on the real money variables.
Chee-Wooi Hooy looks at the implication of exchange rate from another perspective. His article entitled “Exchange Rate Volatility Spillover Effect” explains that exchange rate has great impact on regional economic integration. It is well-known that following the collapse of the Bretton Woods fixed exchange rate arrangement in March 1973, exchange rates of most the countries in the world including those in the ASEAN region are experiencing substantial fluctuation and at times excessive volatility. However, excessive exchange rates volatility inserts tremendous pressure on inter- and intra-regional trade competitiveness, hindering the objective of forming a free trade area in regional economies. Thus, according to Hooy, the understanding on how a group of regional currencies discount common shock and absorb increased volatility due to the fast pace of globalization and financial deregulation among emerging markets during the last two decades is of significant importance in ensuring persistent trade and monetary coordination subsist among member countries in the ASEAN region. His empirical results indicate that Japanese yen plays a dominant role in explaining the volatility system of the ASEAN-5 currencies, but not the pound sterling. On the other hand, Philippines peso and Thai baht behave exogeneously in the volatility system. Meanwhile both Indonesian rupiah and Malaysian ringgit have extensive exposure to their neighbouring currencies’ volatilities. Hooy’s findings, among others, also demonstrate the important role of Japan in influencing the economic development and structural changes of ASEAN-5, thereby providing the groundwork for the formation of yen bloc in this region.
Due to its importance to open economies, policy makers, foreign investors and other financial market players use to pay great attention to understand the exchange rate movement. One way to trace the exchange rate movement is from the purchasing power (PPP) perspective as the PPP postulates that in the long run, exchange rate and relative prices should move together. Surprisingly, in sharp contrast to PPP hypothesis, Kian-Ping Lim, Hock-Ann Lee and Evan Lau in their article titled “Cointegration Tests of Purchasing Power Parity” find no co-movement relationship between ASEAN-5 exchange rates no matter the numeraire currency is US dollar or Japanese yen, based on the conventional Johansen and Juselius cointegration test. Nonetheless, co-movement relationship is uncovered by Bierens’ non-parametric cointegration test, which does not require the assumption of linearity as in the former test and therefore the latter finding is more robust. Hence, they conclude that PPP actually holds in the case of ASEAN-5 exchange rates. The authors further observed that stronger evidence if PPP is provided by the yen-based rather than the dollar based exchange rates. This suggests that ASEAN countries are more closely linked with Japan than US in terms of economic activities, thereby providing another evidence, in conjunction with the study of Hooy, on the formation of yen bloc in this region.
Apart from the cointegration method, one may approach the testing of PPP hypothesis from the unit root perspective. However, in the past, both methods produce equally many mixed results, rendering the PPP a controversial and therefore hotly debated issue. In an attempt to reconcile the inconclusive evidence on PPP, the article on “Unit Roots of Purchasing Power Parity” written by Venus Khim-Sen Liew points out that the negligence of non-linearity may be the main cause of the contrasting findings in the literature. The author shows from the perspective of unit root tests that conventional tests, which are constructed in the linear frameworks have low power in the presence of non-linearity, thereby yielding misleading results. Having this setting in mind, then the apparently surprising contrasting results due to different methodologies (Johensen and Juselius cointegration test and Bierens’ non-parametric cointegration test) in the work of Kian-Ping Lim, Hock-Ann Lee and Evan Lau in the previous article may be explained by the failure of the former to account for nonlinearity, which has been shown presence in this region under study in the work of Kian-Ping Lim and Venus Khim-Sen Liew.
Besides the understanding the exchange rate movements, stock market behaviour is also of great interest to financial market participants. In particular, forecasting stock market movement is a crucial task in decision-making process for equity market investors. Venus Khim-Sen Liew, Kian-Ping Lim and Chee-Keong Choong demonstrate the usefulness of various most contemporary linear and non-linear time series models in this respect. They reveal in their article entitled “Forecasting the Stock Markets Returns” that both linear and non-linear time series models give better prediction than the random walk model, investors may yield profits by carefully designing their investment strategy based on properly selected time series models.
Of late, numerous studies in the scope of financial economics have discovered the presence of non-linearities in financial markets in developed countries. Out of inquisitiveness, Kian-Ping Lim and Venus Khim-Sen Liew examine the linearity nature of foreign exchange and stock markets in the ASEAN region. They find evidence of non-linear dependencies and STAR-type non-linearity in the exchange rate and stock market returns. Their findings, while lighting the fact that researchers cannot take the linear assumption as granted, also point to the need to test for non-linearity as a preliminary diagnostic tool to determine the nature of the data generating process before any further empirical analysis. Their article titled “Non-Linearity in Financial Markets” contains more details.
In a separate endeavor, Kian-Ping Lim in his article on the topic “Episodic Behaviour in Financial Markets” reveals that the non-linearity presents in the ASEAN financial markets is indeed episodic and transient in nature. This finding, which suggests that at times these markets are forecastable, while unpredictable at other times, may be taken as evidence to reconcile the controversy between the efficient market hypothesis and behavioral science.
In the later half of 1980s and early years of 1990s, most of the government of ASEAN countries gradually liberalized their stock markets, given investors the opportunity to invest in domestic securities. One question in mind is: Can investment risks within this region be diversified through distributing investment funds in various ASEAN stock markets? It is pointed out by Kian-Ping Lim, Hock-Ann Lee and Venus Khim-Sen Liew in their article titled “Stock Markets: International Diversification Benefits?” that in the long run there is no diversification benefit by doing so. The authors put forward that the strong economic ties in this region lead to co-movement in these stock markets, thereby making risk diversification not possible.
To wrap up this introduction chapter, some major implications of the above findings could be summarized as follows:
First, there is an urgent need to narrow down the output gap between Singapore and the rest of the countries in the ASEAN region to foster economic integration. In this regards, ASEAN governments that have been found more influential than market free force should work together to enhance regional economic growths via improving the conditions of domestic accumulation, technological capability and productivity efficiency in this region in their efforts to attract more foreign direct investment, whilst maintaining low level of inflation.
Second, the evidence of purchasing power parity in this region with regard to Japan and the findings of dominant role of yen in influencing the ASEAN exchange rates in this book in principle lend us support to the proposed formulation of yen bloc for the benefits of ASEAN in particular and Asian in general. Based on this groundwork, policy makers and academics researchers are encouraged to further explore for the means of achieving this goal.
Third, countries with large and persistent external imbalances due to trade deficits are vulnerable to potential currency attack. Hence, managing unsustainable trade deficits may help to safeguard a country from the unwanted disaster. To do improve trade deficits, policy measures should, among others, focus on the real money variables.
Fourth, ASEAN exchange rate and stock markets do not follow the drunken man’s random walk movements, as would the efficient market hypothesis suggest. These markets are found predictable by the carefully devised time series models. Nonetheless, one must be aware of the episodic behavior of these financial markets, which imply that one must understand the linearity nature of the dynamics of these markets to yield any reliable and profitable forecasts.
Fifth, as there are some evidences of stock markets linkage among the ASEAN countries due to close economies ties, equity market investors who are of course most welcomed to invest their funds here should seek for risk diversification in markets outside this region at the same time.
Finally, consistent with the findings elsewhere for developed countries, it has been shown that non-linearities are common characteristic of financial markets in this region. As such, researchers can no more safely take the linear assumption as granted. Instead, in the interests of soliciting robust empirical findings and rigid policy recommendations, testing of non-linearity should be the first and foremost exercise before any further empirical analysis in this field of work.
Venus Khim-Sen Liew
Kian-Ping Lim
Hock-Ann Lee
