Evidence of Global Financial Shocks Transmission: Changing Nature of Stock Markets Integration during the 2007/2008 Financial Crisis

The study aims to empirically examine the nature of integration among the Malaysian stock market with two of the world's biggest stock markets, namely the US and Japan, during the global financial crisis in 2007/2008. By assessing the changes in the nature of integration among these markets during the crisis, the study aims to find evidence on the international transmission of the financial shocks through the global stock markets. The study covers the period from September 1, 2006 to May 30, 2009. In efforts to capture the changing nature of integration among the stock markets, the sample period is divided into three subperiods, namely the pre-crisis period, during crisis period I and during crisis period II. In methodology, the study relies on the recent empirical tests of cointegration, impulse response functions and variance decomposition analysis. The study finds that the nature of integration among the these markets changes over the three periods due to the crisis. In particular, the markets are shown to be highly integrated at the initial stage of the crisis. However, as information became clearer and it is evident that the crisis is prolonged, investors opt for other types of investment than the equity markets, resulting in all the markets to perform independently. (ProQuest: . denotes formulae omitted.)1. IntroductionStudies documenting increasing integration among the global financial markets are abundant, often focusing on the integration of the national stock markets. There seems to be a tendency towards a general consensus that the international links among the stock markets have been increasing over the past decades, particularly those in the major financial centers (see, for example, Goldstein and Michael, 1993; Blackman and Holden, 1994; and Hanna et al., 1999). This trend is largely attributed to the increased efficiency in the financial markets that facilitate capital flows across the globe. As suggested by Blackman and Holden (1994), stock markets are more segmented in the 1970s compared to the 1980s due to restrictions in capital flows, high transaction costs and information difficulties in the earlier period. The study by Hanna et al. (1999) on the nature of integration among six developed equity markets, namely the UK, France, Germany, Italy, Japan and Canada in the 1990s further lend support to these findings as the results reveal that these stock markets are highly integrated with each other, thus fail to offer any diversification benefits to the investors.While integration among the global stock markets has increased, deeper investigations reveal the time-varying aspect of the stock market integration. Many studies have shown that the nature of integration among the stock markets could be changing over different sample periods. The study by Bekaert and Harvey (1995) which focuses on twelve emerging stock markets finds the time-varying integration among these stock markets. In particular, the study finds that several of the stock markets are segmented in one part of the sample and become integrated in another part of the sample. The different nature of the stock market integration is attributed to the regulatory changes over the sample periods, including the lifting of capital market restrictions to foreign investors. In the case of the major ASEAN countries, Click and Plummer (2005) find that the stock markets of the major ASEAN countries become increasingly integrated in the post-1997 financial crisis compared to before the crisis period as member countries intensify their efforts towards financial sector integration in advent of the macroeconomic integration.The recent US 2007 sub-prime crisis has renewed the research interests to understand the impact of financial crisis on the stock market integration. For the case of the US 2007 crisis, to our knowledge, there are limited studies focusing on the impact of the US financial crisis on other stock markets due to the recent nature of the crisis. …