Does Intra‐regional Trade Matter in Regional Stock Markets? New Evidence from the Asia‐Pacific Region

• Author: Moon Jung Choi,Young‐Min Kim,Sei‐Wan Kim
• Date: 01 September 2019
• Published date: 01 September 2019
• DOI: http://doi.org/10.1111/asej.12186

Does Intra-regional Trade Matter in Regional

Stock Markets? New Evidence from the

Asia-Pacific Region

Sei-Wan Kim, Moon Jung Choi and Young-Min Kim

We provide new evidence on the relationship between bilateral trade and stock

market returns across the Asia-Pacific region. Using three country blocs in this

region, including the Far Eastern bloc, the Chinese bloc and the Australian bloc,

we examine whether trade linkages between countries affect their stock returns.

Incorporating two distinct dynamic properties of regime shifting and cointegration

in intra-regional trade and stock market returns, we employ the newly suggested

multivariable smooth transition autoregressive vector error correction model

(STAR-VECM). A series of estimations reveals evidence that bilateral trade sig-

nificantly Granger-causes stock returns in the Asia-Pacific region, with effects that

are asymmetric depending upon the stock market regime and the country pair.

Among the three blocs, the Far Eastern bloc displays a more pronounced positive

effect of bilateral trade growth on stock returns than do the other blocs.

Keywords: regional trade, stock markets, regime change, smooth transition

autoregressive model.

JEL classification codes: F15, G14, C40, C51.

doi: 10.1111/asej.12186

I. Introduction

Since the 2000s, trade within the Asia-Pacific region has increased much faster

than the world average. For instance, trade among eight sample countries within

*Kim: Department of Economics, Ewha Womans University, 52, Ewhayeodae-gil, Seodaemun-

gu, Seoul 03760, Republic of Korea. Email: swan@ewha.ac.kr. Choi: Economic Research Institute,

The Bank of Korea, 55 Namdaemun-ro, Jung-gu, Seoul 04531, Republic of Korea.

Email: mjchoi@bok.or.kr. Kim (corresponding author): Division of Global Human

Resources (Regional Economics Major), Kangwon National University, 346 Jungang-ro, Samcheok-

si, Gangwon-do 24341, Republic of Korea. Email: ymkim1@kangwon.ac.kr.

The authors are grateful to WoonGyu Choi, Geun-Young Kim, Hyun Hak Kim, Seungwon Kim,

Ahrang Lee, Jaerang Lee, Hyung-kwon Jeong, Kum Hwa Oh, Seryoung Park, Wook Sohn, anony-

mous referees and seminar participants at the Bank of Korea and at the Korea International Eco-

nomic Association Annual Meeting for their helpful comments. We also thank Michael Marking for

careful editing. The views expressed herein are those of the authors and do not necessarily reflect the

official views of the Bank of Korea. This work was supported by the Ministry of Education of the

Republic of Korea and the National Research Foundation of Korea (NRF-2019S1A5A2A01041891).

© 2019 East Asian Economic Association and John Wiley & Sons Australia, Ltd

Asian Economic Journal 2019, Vol.33 No. 3, 253–279 253

the Asia-Pacific region increased by 3.5 times in nominal terms (from US

$1.18tn to US$4.14tn) between 2000 and 2013, while world trade grew by just

2.8 times (from US$12.96tn to US$37.31tn) during this period (IMF, 2017).

The spread of global value chains and the growth of intermediate goods trade in

the region have made its economies more dependent on one another. At the

same time, financial markets, particularly stock markets, have also developed

enormously in this region. Based on the fact that many Asia-Pacific countries

are trade-dependent economies with high trade intensities, it seems likely that

this growth in their trade significantly affects that in their stock markets. Trade

may affect their financial sectors, as more financial transactions occur with the

increased trade. Firms’trade performances should also directly and indirectly

affect their stock values. Considering that stock markets quickly reflect firms’

performances along with macroeconomic activities, the stock markets in Asia-

Pacific countries should show connections with and be affected by their gr owth

in trade. Against this backdrop, the present paper aims to investigate how the

bilateral trade between Asia-Pacific countries affects their stock markets.

While there have been many studies examining the relationship between

stock markets and the trade linkages among countries, we focus on the Asia-

Pacific region. We consider the distinct characteristics of trade and stock

market movements in the region to set up a more appropriate empirical speci-

fication.

1

One of the challenges in investigating the relationship is that

regime changes in the stock markets (i.e. between booms and recessions)

have to be taken into account because the boom-and-bust stock market cycle

of the Asia-Pacific region is known to change more frequently, with the indi-

vidual regimes persisting for much shorter times, compared to the cases of

mature stock markets such as those in the G7 economies (Edwards et al.,

2003; Kim et al., 2015). Another challenge is the long-run comovements of

stock indices between countries, which need to be considered in the model

specification (Azman-Saini et al., 2002; Wongbangpo and Sharma, 2002;

Valadkhani and Chancharat, 2008). Unless these dynamic properties are con-

sidered, the probability of misspecification in the empirical framework will

be high.

We therefore investigate the mutual relationships between stock markets and

intra-regional bilateral trade by incorporating the two distinct features of

endogenous regime changes and cointegration between stock markets in a

smooth transition autoregressive vector error correction model (STAR-

VECM). The STAR-VECM methodology allows us to identify the boom and

1 Empirical evidence that trade linkages between countries is a significant determinant of their

stock market comovements has been shown in the following studies: Chen and Zhang (1997),

Bracker et al. (1999), Soydemir (2000), Pretorius (2002), Chinn and Forbes (2004), Chambet and

Gibson (2008), Tavares (2009), Beine et al. (2010), Walti (2011) and Paramati et al. (2016). Other

studies such as Liu et al. (2006), Bracker et al. (1999), Johnson and Soenen (2002) and Narayan

et al. (2014) show that the effect of trade on stock markets is not always positivebut depends on the

country group and the trade structure.

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