International Research Journal of Finance and Economics

ISSN 1450-2887 Issue 58 (2010)

EuroJournals Publishing, Inc. 2010
http://www.eurojournals.com/finance.htm

Volatility Linkages among India, Hong Kong and Singapore

Stock Markets
Nikolaos Sariannidis
Corresponding Author, Lecturer- Technological Education Institute of West Macedonia
Kila, 50100 Kozani, Greece
E-mail: sarn@hol.gr
Tel: +302461024694
George Konteos
Lecturer- Technological Education Institute of West Macedonia
67 Makedonomachon Str., 50200 Greece
E-mail: gkonteos@hol.gr
Tel: +302463022859
Evangelos Drimbetas
Assistant Professor-Democritus University of Thrace
P.O.Box 418 Kardia, 57500 Thessaloniki, Greece
E-mail: e.drimpetas@solidus.gr
Tel: +302310360701
Abstract
This paper analyzes the volatility linkages among three Asian stock exchange
markets, namely India, Singapore and Hong Kong, during the period July 1997 to October
2005. We use a multivariate GARCH model to identify the source and magnitude of
spillovers. The empirical analysis showed that the markets exhibit a strong GARCH effect
and are highly integrated reacting to information which influence not only the mean returns
but their volatility as well.

Keywords: Volatility, Multivariate GARCH, Asian stock markets

JEL Classifiaction Codes: G14, G15, C22

1. Introduction
The transmission of volatility between markets has been studied extensively in recent years.
Globalization has brought about market integration, especially in stock markets, a fact which attracted
the researchers interest about the transmission of volatility among markets. A common conclusion of
contemporary theoretical and empirical approaches in the literature is that the first and second
moments are positively related. Most researchers (Agmon, 1972; Eun and Shim, 1989; Koch and Koch,
1991; Knif and Pynnonen, 1999; Tay and Zhu, 2000; Dekker, Sen and Young, 2001; Sariannidis,
Koskosas, Garefalakis and Antoniadis; 2009) concluded that, as markets become integrated, the U.S.
market or other large markets, which play a major role in their broader area, exert strong influence on
returns and/or volatilities of smaller markets.

International Research Journal of Finance and Economics - Issue 58 (2010)

142

However, in recent years, the investigation of the interaction between volatilities of advanced
stock markets using multivariate GARCH models becomes more and more interesting (Karoly, 1995;
Theodossiou and Lee, 1995; Koutmos, 1996; Kanas, 1998), since news is produced in all markets,
whether large or small. Under this logic, some researchers (Christofi and Pericli, 1999; KaschHaroutounian and Price, 2001; Fernandez-Lzquierdo and Lafuente, 2004; Worthigton and Higgs, 2004)
proceeded in testing this hypothesis using multivariate GARCH models.
In recent years the markets of South and Southeast Asia attracted interest due to their
dynamism and the relatively large rate of growth of the respective countries. Specifically, In, Kim,
Yoon and Viney (2001), investigated the interdependence, the transmission mechanism and the
integration of three Asian markets, Hong Kong, South Korea and Thailand, using a multivariate VAREGARCH model. Their results indicated that South Korea exerts a weak influence in the other
markets, playing a lesser role as information producer, whereas Hong Kong is a major information
producer, emitting volatility in other Asian markets. In the same direction, De Santis and Imrohoroglu
(1997), using a multivariate GARCH model, proved that some emerging markets exhibit reduced
volatility as capital mobility increases. This has been attributed to two reasons: firstly, to the increase
in the number of stocks included tin the national indexes which means increased diversification and
secondly to the increased participation of foreign investors after capital movements liberalization,
which means increased depth, information and efficiency of the market. Worthington and Higgs
(2004), examined the transmission of equity returns and volatility among three developed markets
(Hong Kong, Japan and Singapore) and six emerging markets (Indonesia, Korea, Malaysia, the
Philippines, Taiwan and Thailand). The results of the multivariate GARCH model that they have used
showed not homogeneous mean spillovers from the developed to the emerging markets and higher own
volatility spillover than cross volatility spillovers, especially for the emerging markets. Also,
Gunasinghe (2005) examined the integration behavior and volatility spillover transmission across the
stock markets of Sri Lanka, India and Pakistan based on a multivariate cointegration test and
generalized impulse response functions. He concluded that the Indian stock market may have some
marginal spillover effect on Sri Lanka and Pakistan stock price movements. Finally, Li (2007) has
examined the linkages among the stock markets of Shanghai Shenzhen, Hong Kong and United States.
The approach that he has used is the multivariate GARCH, and more specifically the BEKK model,
proposed by Engle and Kroner (1995). The results suggested that the magnitude of the volatility
linkages is small, indicating a weak integration of the emerging stock exchanges in mainland China
with this of Hong Kong.
Even though there are a large number of studies on the volatility transmission among Asian
markets, the relationship of the volatilities of the developed markets of Hong Kong and Singapore and
the rapidly developed Indian market, which plays a dominant role as an investment centre in South
Asia, has not been described adequately. The contribution of this paper is that the volatility and shock
transmission mechanism among the above markets is examined using a multivariate GARCH model.
Specifically, we employ a trivariate GARCH model to simultaneously estimate the mean and
conditional variance using daily returns from July 1, 1997 to October 31, 2005. We find significant
volatility transmission among the markets under investigation. Our results are important for buildings
accurate asset pricing models, forecasting volatility, and will further our understanding of the equity
markets. Additionally, since different financial assets are traded based on these market indexes, it is
important for financial market participants to understand the volatility transmission mechanism over
time and across markets in order to make optimal portfolio allocation decisions.

2. Indices used, Data and Preliminary Results

Of the 22 stock exchanges in the country, Mumbai's (earlier known as Bombay), Bombay Stock
Exchange (BSE) is the largest, with over 6,000 stocks listed. The BSE accounts for over two thirds of
the total trading volume in the country. Established in 1875, the exchange is also the oldest in Asia.

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The market capitalization of the BSE is Rs. 5 trillion (some 800bn US$). The BSE Sensex (BSE) is a
widely used market index for the Bombay Stock Exchange.
The Hong Kong Stock Exchange (HKSE), established at the end of the 19th century, today,
with its total securities market capitalization of a record sum of HK$ 8,260.3bn (US$ 1,063.9 trillion),
ranks 8th place by market capitalization in the world. The Hang Seng (HSI), started in 1969, is the
leading index for shares traded in the HKSE. The index consists of the 33 largest companies and
represents approximately 70% of the value of all stocks traded in the HKSE.
With Singapore now a leading financial center in the Asia-Pacific, the Singapore Exchange
(SGX) has become one of the premier exchanges in the region. It is a highly international exchange,
with 40% of its market capitalization coming from foreign companies. The Strait Times Index (STI) is
the main index of SGX, consisting of 50 constituent stocks listed on the Singapore Exchange Securities
Trading Limited (SGX-ST), formerly known as the Stock Exchange of Singapore (SES).
This study uses daily closing stock index data for three major markets of Southeast Asia, for the
period July 1, 1997 to October 31, 2005. The data have been obtained from the Comstock database.
The three indices analyzed are the BSE (India), the HSI (Hong Kong), and the STI (Singapore). In
addition, the daily values of the DJ index have been used to isolate the systematic factors concerning
general international factors.
As shown in Table 1, the HSI and the STI indices are highly correlated (0.62). This fact was
expected since increased interactions exist between the two countries which are geographically close to
each other and they have extensive commercial, economic and political links. Moreover, the
correlations of BSE with HSI and STI are 0.207 and 0.243 respectively, a fact attributed to the
extroversive features of the Indian economy in recent years. The correlations of DJ, with BSE, HSI and
STI are 0.126, 0.303 and 0.334 respectively.
Table 1:

Correlations of Indices

DJ (with one lag)

BSE
SGX-ST
HIS

DJ (with one lag)

1.000
0.126
0.303
0.334

BSE
0.126
1.000
0.207
0.243

STI
0.303
0.207
1.000
0.620

HSI
0.334
0.243
0.620
1.000

The mean returns of all series are not statistically different from zero. The coefficients of
skewness and kurtosis indicate that the series have asymmetric and leptokurtic distribution. The Jarque
Bera test rejects the normality of the return series. The augmented Dickey - Fuller (ADF) test,
allowing for both an intercept and a time trend, showed that the BSE returns series had been produced
by a stationary series. The Ljung Statistics for 1, 3 and 12 lags applied on returns (denoted by LB(n))
and squared returns (denoted by LB2(n)) indicate significant time dependence of the first and second
moments. Therefore, a multivariate GARCH model that takes into account the ARCH effects that all
series exhibited in the mean is an appropriate model.
Table 2:

Sample statistics of BSE, HSI and STI returns

Statistics
Mean
Std. Dev.
Skewness
Kurtosis
Jarque-Bera
Augmented Dickey-Fuller (ADF)
Observations
LB(1)
LB(3)
LB(12)
LB2(1)
LB2(3)
LB2(12)

BSE
0.000294
0.016153
-0.32349
6.640
1175
-42.3
2063
10.553
15.432
43.285
183.36
256.73
370.44

HSI
-0.000078
0.017318
-0.204156
10.513
4866
-24.4
2063
8.4983
22.858
34.067
76.686
344.01
581.72

STI
0.000139
0.014684
0.405903
12.806
8323
-39.2
2063
43.449
43.792
55.785
58.301
146.83
474.8

International Research Journal of Finance and Economics - Issue 58 (2010)

144

3. Empirical Framework and Estimation Results

Considering the international literature and the preliminary results cited above, the BEKK model of
Baba, Engle, Kraft, and Kroner (1989) renders a very good choice for modeling the volatility
transmission among BSE, HSI and STI indexes. The following mean equations were estimated for each
markets own returns and the returns of other markets lagged one period:
Rt = d + GRt 1 + t
(1)
where Rt is an nx1 vector of daily returns at time t for each market, t/It-1~N(0, Ht) is an nx1 vector of
random errors for each market at time t, It-1 represents the market information that is available at time t1 with its corresponding nxn conditional variance-covariance matrix, Ht. The diagonal elements gii of
matrix G are the respective markets own returns lagged one period, while the off-diagonal elements gij
represent the mean spillover effect across markets. The 3x1 vector di contains constants.
The variance equation that we used in this paper of the following form:
Ht = CC + At-1t-1 +t-1
(2)
where C is a 3x3 lower triangular matrix of constants, and A is a 3x3 square matrix which shows how
the conditional variances are correlated with past squared errors. The elements of matrix A measure the
effects of shocks or news on the conditional variances. The 3x3 square matrix B shows how past
conditional variances affect the current levels of conditional variances, in other words, the degree of
volatility persistence in conditional volatility among the markets. For the empirical implementation it is
desirable to restrict further the above parameterization. Of the two most popular parameterizations for
the multivariate GARCH models, VECH and BEKK, we adopted the BEKK parameterization, because
this model is designed in such a way that has less parameters and the estimated covariance matrix will
be positive semi-definite, which is a requirement needed to guarantee non-negative estimated
variances. Thus, we have restricted the trivariate BEKK model with 24 parameters to the reduced form
of the diagonal BEKK with 12 parameters. The elements of the covariance matrix Ht, depends only on
past values of itself and past values of tt, which means that the variances depend only on past own
squared residuals, and the covariances depend only on past own gross products of residuals. The
restriction of the diagonal is justified, since information about variances is usually revealed in
squared residuals, and, moreover, if the variances develop slowly, then past squared residuals should
be able to forecast future variances (the same argument holds for the covariances).
In order to estimate the above BEKK system we maximized the following likelihood function
using the Student t-distribution, which accounts for the possible excess kurtosis usually found in the
residuals of stock series in ARCH models:
Tn
1
1
L( ) =
+ ln(2 ) (ln Ht + t' H t t )
2
2 t =1
(3)
where () is a vector of parameters to be estimated, T is the number of observations and n is the
number of markets. The Marquardt optimization algorithm is used to produce the maximum likelihood
parameter estimates and their corresponding asymptotic standard errors.
The estimation results of the multivariate GARCH model with diagonal BEKK
parameterization for each mean equation are reported in Table 3. The results of the mean equation
manifest the huge influence (gi4 = 0.267) that the USA market exerts in the formation of the returns in
all other markets. Also, the coefficients gi1- (0.032) and gi3 (0.051) show that the mean return of the
Indian and the Singapore markets are influenced by they own lagged returns and exhibit mean return
spillovers from lagged returns in the other markets.

145
Table 3:

International Research Journal of Finance and Economics - Issue 58 (2010)

Estimated coefficients for conditional mean returns equations

Estimated
Standard error
coefficient
d1
0.001021*
0.000273
d2
0.000073
0.000244
d3
0.000211
0.000212
gi1
0.032354*
0.012278
gi2
0.012633
0.015607
gi3
0.050972*
0.017619
gi4
0.266829*
0.015897
i takes values from 1 to 4 and refers to the indices BSE, HSI, STI and DJ respectively. * indicates statistical significance at
the 1% level. ** indicates statistical significance at the 5% level.

The coefficient gi2 is not statistically significant, possibly because the information for the Hong
Kong investors derives mainly from the USA market as well as from other large Asian markets which
close after the HKSE (Table 4). This manifests the efficiency of the HKSE, as the prices in this market
incorporate all available information and any information available after market close affects next day
prices. This is probably the reason that we have autocorrelation in the return series of the HSI.
Table 4:

Marketing Opening Times in UTC Time Zone

Exchange Name
Bombay Stock Exchange
Hong Kong Stock Exchange
Singapore Exchange
New York Stock Exchange

Opening Time
4:25 am
2:00 am
1:00 am
2:30 pm

Closing Time
10:00 am
8:00 am
9:00 am
9:00 pm

Table 5 presents the estimated coefficients for the variance covariance matrix of equations.
The conditional variance covariance equations effectively capture the volatility and cross volatility
spillovers among the three Asian markets. From the empirical results we conclude a time variation in
market risk, a strong evidence of GARCH effect and the presence of a weak ARCH effect.
Specifically, equations (4)-(9) present the effects of variance equations implied by the diagonal BEKK
specification. The volatilities h11, h22 and h33 in the Indian, Hong Kong and Singapore markets
2

respectively, show that the coefficient of GARCH effect, which reflects the influence of h t 1 , i.e. the
older information (residuals ut-2, ut-3, ), is much higher than the value of the ARCH coefficient,
which correlates the price variation of the present day to the price variation of the previous day. The
results for the covariance equations are similar, indicating that there is a statistically significant
covariation in shocks, which depends more on its lag than on past innovations. Consequently, market
shocks are influenced by information which is common to the respective markets, and as a result of this
we have statistically significant covariance in the variance covariance equations. The conditional
variances covariances estimated by the diagonal BEKK model are presented in Figure 1.
h11t = 0.0000169 + 0.141,2 t-1 + 0.79h11,t 1
(4)
2
2
h12t = 0.00000288 + 0.0481,t-1 2,t-1 + 0.884h12,t 1h12,t 1
(5)
2
h22 t = 0.00000032 + 0.016 2,t-1 + 0.98h22,t 1
(6)
h13t = 0.00000184 + 0.0571,t-1 3,t-1 + 0.88h13,t 1
(7)
h23t = 0.00000015 2,t-1 3,t-1 + 0.019 2,t-1 3,t-1h23,t 1 + 0.978h23,t 1
(8)
2
h33t = 0.00000043 + 0.022 3,t-1 + 0.974h33,t 1
(9)

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International Research Journal of Finance and Economics - Issue 58 (2010)

Table 5:

Estimated coefficients for variance covariance equations

Estimated
Standard
coefficient
error
C11
0.0000169*
0.0000031
C12
0.00000288*
0.0000007
C13
0.00000184*
0.0000006
C22
0.00000032*
0.0000002
C23
0.00000015**
0.0000001
C33
0.00000043**
0.0000002
A11
0.37707*
0.0250440
A22
0.128127*
0.0099990
A33
0.151215*
0.0102380
B11
0.891956*
0.0126080
B22
0.99153*
0.0014220
B33
0.987217*
0.0018490
* indicates statistical significance at the 1% level. ** indicates statistical significance at the 5% level.

Figure 1: Conditional variances covariances estimated by the diagonal BEKK model

Conditional Variance Covariance
Var(BSE)

Cov(BSE,HSI)

.004

.0004
.0003

.003
.0002
.002

.0001
.0000

.001
-.0001
.000

-.0002
500

1000

1500

2000

500

1000

1500

2000

1500

2000

1500

2000

Observations

Observations

Var(HSI)

Cov(BSE,STI)

.0016

.0004
.0003

.0012
.0002
.0008

.0001
.0000

.0004
-.0001
.0000

-.0002
500

1000

1500

500

2000

Observations

1000

Observations

Cov(HSI,STI)

Var(STI)

.0010

.0014
.0012

.0008
.0010
.0006

.0008

.0004

.0006
.0004

.0002
.0002
.0000

.0000
500
Observations

1000

1500

2000

500
Observations

1000

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International Research Journal of Finance and Economics - Issue 58 (2010)

The overall persistence of the variance covariance equations measured by the sum of the
ARCH and GARCH coefficients provides evidence of strong volatility, which possibly establishes unit
root in variance. Finally, the Ljung Box Q statistics for the 1st (0.1035), 12th (0.1170) and 24th
(0.1687) orders in squared standardized residuals show that there is no series dependence in the
squared standardized residuals, indicating the appropriateness of the diagonal BEKK GARCH model.

4. Conclusions
This study employs the multivariate diagonal BEKK GARCH model to examine the transmission of
returns and volatilities among the markets of India, Hong Kong and Singapore. The estimated
coefficients from the conditional mean return equations indicate that all examined markets are highly
integrated, reacting in common information which mostly derives from the USA market, the largest
information producer in the world. Furthermore, the results indicate that the Hong Kong market is the
most efficient, followed by the markets of India and Singapore.
The magnitude and persistence of the coefficients of the variance covariance equations
indicate that all markets exhibit strong GARCH effects, as old news have a higher impact on
conditional volatility than current news, a fact which implies that markets are probably inefficient and
shocks (news) are slowly absorbed by the market. Furthermore, the magnitude and the statistical
significance of the covariances indicate that volatility formation underlies in commonly available
information, which confirms the argument that stock markets are becoming more integrated.

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