Table Of ContentEmpirical Finance
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Sardar M.N. Islam
Sethapong Watanapalachaikul
Empirical Finance
Modelling and Analysis
of Emerging Financial and Stock Markets
With 53 Figures
and 56 Tables
Springer-Verlag Berlin Heidelberg GmbH
Series Editors
Wemer A. Miiller
Martina Bihn
Authors
Dr. Sardar M. N. Islam
Dr. Sethapong Watanapalachaikul
Centre for Strategic Economic Studies
Victoria University
PO Box 14428
Melboume City MC VIC 8001
Australia
[email protected]
sethapong. watanapalachaikul @vu.edu.au
ISSN 1431-1933
ISBN 978-3-7908-1551-1 ISBN 978-3-7908-2666-1 (eBook)
DOI 10.1007/978-3-7908-2666-1
Cataloging-in-Publication Data applied for
Library of Congress Control Number: 2004109408
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© Springer-Verlag Berlin Heidelberg 2005
Originally published by Physica-Verlag Heidelberg 2005
The use of general descriptive names, registered names, trademarks, etc. in this publication does not imply,
even in the absence of a specific statement, that such names are exempt from the relevant protective laws and
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Softcover Design: Erich Kirchner, Heidelberg
SPIN 11014270 88/3130IDK-5 4 3 2 I 0-Printed on acid-free and non-aging paper
Foreword
This book makes two key contributions to empirical finance. First it provides a
comprehensive analysis ofthe Thai stock market. Second it presents an excellent
expositionofhow modem econometric techniques canbe utilised to understand a
market.
The increasingglobalisation ofthe world's financial markets has made our un
derstanding ofthe risk-return relationship in a broader range ofmarkets critical.
This is particularly so in emerging markets where market depth and liquidity are
majorissues.OnesuchemergingmarketisThailand.TheThaicapitalmarket isof
particular interest given that it was the market in which the Asian financial crises
commenced.As such anunderstanding oftheThai capital market via study ofthe
pre and post-crisis periods enables one to shed light on one ofthe major financial
marketsevents ofrecenttimes.
This book provides a quantitative analysis of the Thai capital market using
some very useful and recent econometric techniques.The book provides an over
view ofthe Thai stock market in chapter 2.Descriptive statistics and time series
models (moving average, exponential smoothing, ARIMA) arepresented in chap
ter 3followedby market efficiency testsbased onautocorrelations inchapter 4.A
richer set ofmodels is then considered inchapters 5 through 8. Chapter 5 finds a
cointegrating relationship between macroeconomic factors and stock returns.
Chapter 6findsevidence ofaspeculativebubblepre-crisisbutnotpost-crisis.This
is a particularly interesting finding. Chapter 7 finds evidence ofcalendar anoma
liesinThai stockreturns.Chapter 8fitsarange ofmodelsfromtheGARCH fam
ilytoThai stockmarket volatility and findsthese modelsdo agoodjob incharac
terisingvolatility.
This book should be of special interest to students, researchers, academics,
practitioners, and policy makers in the areas of finance, banking, economics and
development management.
ProfessorRobertBrooks
Professor ofFinancial Econometrics
Dean(Research & Innovation)
RMITBusiness
RMIT University,Australia
Abstract, Preface and Acknowledgement
Empirical finance (especially financial studies using financial econometrics) is
becoming a verypopular academic discipline in finance.An evidence of this fact
is Professors Engle and Granger's Nobel prize this year (2003) for their work in
financial econometrics. Applying econometric methods to investigate empirical
finance(tounderstandtheempirical characteristicsofthe financialmarket)andits
components such as the stock market is an important area of study in finance not
only for academic investigation, but also for policy formulation and investment
planning purposes. This book undertakes studies on some common financial
econometric methods and issues, some of which havebeen studied by Professors
Engle and Granger, in the context of emerging financial markets of developing
countries.This isanessentialeconometricstudyofempirical developmentfinance
for an exploration of the characteristics of the financial market of the emerging
stockmarketsofdevelopingcountries.
There are substantial differences in the operation and characteristics of finan
cial markets in developed and developing countries in terms of efficiency, stabil
ity,andtheeffectivenessinpromotingeconomicdevelopment.There aredifferent
views about the performance and characteristics of the financial markets in both
thesetypes ofeconomies. Oneviewstressesthepossibility forefficientoperation
of the market leading to efficient allocation of resources while the others high
lights the real life evidence of market failures, market inefficiency, the existence
ofspeculation,bubbles, etc. Thisstudyundertakesanempiricalstudyofthechar
acteristicsofa developingAsian(Thai)financialmarketasacasestudyby apply
ing the methods of financial econometrics to investigate whether and how these
characteristicscorrespond withtheseviews. Emphasis isplaced onunderstanding
those specialcharacteristics of thefinancialsystemofdevelopingcountries which
can cause financial market failures, and the existence of market imperfections
suchasasymmetricinformation,adverseselectionandmoralhazard.
Thepresentbook ispossiblythemostcomprehensivestudyofcrucialissuesaf
fecting the stock market including valuation, predictability, volatility, anomaly
andmarketefficiency. Perhaps,nosuchstudyhasexistedpreviously,makingthis
bookagenuinecontributiontotheliterature.
The stock marketplays a major role ina developing economy's financial sys
tem.While focusing onThailand as acase study, this studyprovides both the re
searcherinquantitativefinancialeconomicsandthestockmarketinvestor,withan
understanding of the financial issues of developing economies in emerging stock
markets especially the Asian stock market which have similar characteristics as
those of the Thai stock market. The financialissues studied in this book include
VIII Abstract,PrefaceandAcknowledgement
market efficiency, valuation, predictability, speculative bubbles, anomalies and
volatilities,among others.
The findings ofthis explorative research ofthe above forms provide informa
tion necessary for understanding the state offinancial development in a country
and formulatingpolicies forcorporate finance,choosingbetween thestock market
vsbank based financial development strategies, and financing economic develop
ment.
A standard set ofall financial econometric methods and models including de
scriptive statistics and time series econometric methods have been adopted inthis
study. Many contemporary techniques, approaches and models are used and in
cludesimplemultivariate regression, runtest,ACF model, multi-factor model,ex
ponential smoothing, Holt Winter's model, ARIMA, TSMM, Duration Depend
ence Test, Weibull Hazard, time-series regression model with dummy variable,
and GARCH type models. They are developed in order to examine the financial
econometricissues oftheThai stockmarket. Data fortheperiod of 1975to 2001
areusedtoundertaketheseeconometricmodelingexercises.
The empirical investigations provide useful information about thebehaviour of
the Thai financial time series data related to the fair game, white noise, random
walk, martingale, stationarity, error correction, cointegration and diffusion proc
esses.
In terms ofthe operation ofthe Thai financial system and stock market, this
studyprovides someusefulinsights. Allthecharacteristics oftheStockExchange
of Thailand analysed in terms ofmarket index prices and returns reveal evidence
ofinefficiency in the market. Substantial empirical evidence supports the rejec
tion ofthe hypothesis ofthe stock price process being white noise in both the
short-term and long-term analysis. The notion ofexisting market inefficiency is
supported by the presence ofrational bubbles, anomalies and volatility. Anoma
liesinthe stockmarket (in theformofMonday andtheJanuary effects) wereevi
dent during the 1992-1996 (the pre-crisis) and 1997-2001 (the post-crisis) peri
ods. The existence ofspeculative bubbles in the stock market was confirmed by
the test models. In addition, volatility in the stock price was high in 1992, 1993,
1997and 1998after theThai financial crisis. High volatility in stock prices and
returns was also found inJanuary,February and December. Empirical estimation
ofstockvaluation modelsreveals thatmanyeconomic factorsarethedeterminants
ofthe value ofThai stock such as the interest rate, bonds yield, foreign exchange
rates,price earningratio,marketcapitalization,andtheconsumerpriceindex.
These characteristics ofthe emerging stock markets are due to the level ofde
velopment of the financial systems, institutions and socioeconomic structure in
developing countries. Some welfare economics aspects offinance covering these
issuesarealsostatedinthisstudy.
The findings ofthis study provide justification for governments in developing
countries adopting financialpoliciesdesigned to evolve adeveloped, efficient and
social welfare maximising financial market which can ensure efficient allocation
offinancialresources.
Suggestions for further study inthis area and directions for futureresearch are
alsoincluded.
Abstract,PrefaceandAcknowledgement IX
This study argues for treating empiricaldevelopmentfinance as aseparate dis
cipline in finance since this description can provide information, both analytical
and empirical, useful forproper understanding the development process in devel
opingcountries.
Sincethisbook isarigorousresearch studyinfinance,itcanbeused asarefer
ence book by researchers, academics, practitioners, policy markers, and post
graduate students intheareaoffinance,financialeconometrics, financialeconom
ics, monetary economics, and development economics. It can also be used as a
textbook onempirical financeorfinanceintheemerging markets orasareference
orasanadditionaltextforafinancesubjectattheMasters orDoctoral level.
The authors wish to thank M. Kumnick, R. Gupta and M. Clarke forproviding
research and editorial assistance inpreparing this book. This book has benefited
from the generosity ofN.Billington and P.Sheehan formaking the necessary re
sources available and sharing their knowledge, experience and encouragement in
bringing ittocompletion.
SardarM.N.IslamandSethapongWatanapalachaikul
CenterforStrategicEconomic Studies
VictoriaUniversity
Melbourne,Australia
April2004
Contents
Foreword V
Abstract,Prefaceand Acknowledgement.. VII
1Introduction 1
1.1Introduction 1
1.2FinancialSystemand Issues 2
1.3Characteristics ofthe EmergingStockMarketsinDevelopingCountries 3
1.4FinancialEconometrics: Methodsand Models 5
1.5The ThaiFinancialSystemand the EmergingStockMarket 5
1.6LimitationsofExistingLiteratureand theMotivation 6
1.7The Objectivesofthe Study 7
1.7.1Objectives 7
1.7.2WelfareEconomicsofFinance: Policies and Institutions 7
1.8Contributions ofthis Research 8
1.9EconometricMethodologiesand SourcesofData 8
1.9.1EconometricMethodologies 8
1.9.2Sources ofData and ComputerPrograms 9
1.10 Structureofthe Book 10
1.10.1 ChapterStructure 10
1.10.2 GeneralStructure 11
2 TheThaiFinancialSystem: Characteristicsof theEmergingThaiStock
Market 13
2.1 Introduction 13
2.2Financialand CapitalMarkets 13
2.2.1The Central Bankand CommercialBank 15
2.2.2Moneyand Capital Markets 16
2.2.3ForeignExchangeMarket 17
2.2.4 StockMarket: GeneralCharacteristics 18
2.3RecentIssues 21
2.3.1 FinancialLiberalisation 21
2.3.2Economic Crisis 21
2.3.3Focus onForeignCapitalFlows 22
2.3.4UnstableExchangeRate inan OpenEconomy 22
2.3.5MarketImperfection 23
XII Contents
2.4 Conclusions 23
3DescriptiveStatistics and GeneralCharacteristicsoftheStockMarket 25
3.1Introduction 25
3.2Descriptive Statistics 25
3.3Univariate Time SeriesModelling 31
3.3.1MovingAverage 33
3.3.2ExponentialSmoothing 36
3.3.3HoltWinters' MultiplicativeMethod 44
3.3.4ARIMA Models 49
3.5 Implicationsand Empirical Characteristics 50
3.6Conclusion 51
4MarketEfficiencyModels and Tests 53
4.1Introduction 53
4.2Market EfficiencyHypothesis 54
4.2.1The Concept 54
4.2.2EMH andTime SeriesBehaviour 56
4.3StockMarket EfficiencyTests 58
4.3.1RunTest 58
4.3.2AutocorrelationFunctionTest 60
4.4The Market EfficiencyoftheThaiFinancialSystem 62
4.5 Conclusions 63
5StockValuationModels 65
5.1Introduction 65
5.2 Literature Review:Why aMultifactor Model? 66
5.2.1The Rational Valuation ModeL 66
5.2.2 Capital Asset Pricing Model(CAPM) 68
5.2.3The Arbitrage PricingTheory 74
5.2.4 Estimation ofthe ValuationModel 76
5.2.5Limitation ofCurrent Models 76
5.2.6RelationbetweenMacroeconomicFactors and StockPrices 77
5.3Models, EconometricsMethodologyandData 77
5.3.1Variable Selection,MacroeconomicandInternationalFactors 77
5.3.2Multi-FactorModel. 80
5.3.3Data 80
5.4Results and Implications forValuation 81
5.4.1 UnitRoot and CointegrationTest 81
5.4.2The FactorsDeterminingtheValues oftheStocks 86
5.5 CointegrationTest ofthe Six-VariableModel 87
5.6The Real Value ofStocks 88
5.7Conclusions 88
6Modelsfor RationalSpeculativeBubbles 91
6.1 Introduction 91
