1 Dynamic Connectedness in Emerging Asian Equity Markets *

Abstract: This paper examines dynamic connectedness among emerging Asian equity markets as well as explores their linkages vis-à-vis other major global markets. We find that international equity markets are tightly integrated. Measuring connectedness based on a generalized Vector Autoregressive model, more than half of all total forecast error variance in equity return and volatility shocks come from other markets as opposed to country own shocks. When examining the degree of connectedness over time, we find that international stock markets have become increasingly connected, with a gentle upward trend since the Asian financial crisis but with a rapid burst during the global financial crisis. Despite the growing importance of Asian emerging markets in the world economy, we find that their influence on advanced economies is still relatively small, with no significant increase over time. During the past decade, advanced markets have been consistently net transmitters of shocks while emerging Asian markets act as net receivers. Based on the nature of equity shock spillovers, we also find that advanced countries are still tightly connected amongst themselves while intraregional connectedness within Asia remains strong. By investigating whether uncertainty plays an important role in explaining the degree of stock market connectedness, we find that economic policy uncertainty from the US is an important source of financial shock spillover for the majority of international equity markets. In contrast, US financial market uncertainty as proxied by the VIX index drives equity market spillovers only among advanced economies. This paper examines dynamic connectedness among emerging Asian equity markets as well as explores their linkages vis-à-vis other major global markets. We find that international equity markets are tightly integrated. Measuring connectedness based on a generalized Vector Autoregressive model, more than half of all total forecast error variance in equity return and volatility shocks come from other markets as opposed to country own shocks. When examining the degree of connectedness over time, we find that international stock markets have become increasingly connected, with a gentle upward trend since the Asian financial crisis but with a rapid burst during the global financial crisis. Despite the growing importance of Asian emerging markets in the world economy, we find that their influence on advanced economies is still relatively small, with no significant increase over time. During the past decade, advanced markets have been consistently net transmitters of shocks while emerging Asian markets act as net receivers. Based on the nature of equity shock spillovers, we also find that advanced countries are still tightly connected amongst themselves while intraregional connectedness within Asia remains strong. By investigating whether uncertainty plays an important role in explaining the degree of stock market connectedness, we find that economic policy uncertainty from the US is an important source of financial shock spillover for the majority of international equity markets. In contrast, US financial market uncertainty as proxied by the VIX index drives equity market spillovers only among advanced economies.