Stock market integration in ASEAN after the Asian financial crisis

Members of the Association of Southeast Asian Nations (ASEAN) have recently made progress in forming a free trade area and investment zone, and are now examining the possibility of stock market integration. Regional integration may be fostered by simply coordinating existing national stock markets or, at an extreme, by creating a supranational exchange. Financial theory suggests that an integrated regional market is more efficient than segmented national markets, and this is what’s driving the interest in ASEAN stock market integration -- particularly after of the Asian financial crisis of 1997-1998. From the perspective of a portfolio investor, integration of markets suggests that the separate markets move together and have high correlations, so there is less benefit from portfolio diversification across countries. The issue of stock market integration is thus of interest to ASEAN policymakers and international portfolio investors alike. This paper considers the degree to which the five stock markets in the original ASEAN countries (ASEAN-5) are correlated as a way to assess the feasibility of ASEAN stock market integration and the implications for portfolio investors. In particular, this paper considers whether the ASEAN-5 markets are integrated or segmented using the time series technique of cointegration to extract a long-run relation. The empirical results suggest that the ASEAN-5 stock markets are cointegrated and are thus not completely segmented by national borders. However, there is only one cointegrating vector, leaving four common trends among the five variables. We therefore conclude that ASEAN-5 stock markets are integrated in the economic sense, but that integration is not complete. On a policy level, initiatives to further integrate the stock markets are feasible, and in fact desirable. From the perspective of the international portfolio investor, benefits of international portfolio diversification across the five markets are reduced but not eliminated. This paper was initiated while the authors were Visiting Researchers at The International Center for the Study of East Asian Development (ICSEAD) in Kitakyushu, Japan, during the Summer of 2002. We are grateful for financial support from ICSEAD during this period. We are also grateful for valuable comments from Eric Ramstetter, Kiyotaka Sato, Oleksandr Movshuk, Atsuko Matsuoka, and other seminar participants at ICSEAD.