Financial integration and diversification benefits: China and ASEAN4 countries

Abstract

Purpose – The strategic partnership between China and ASEAN has resulted in significant financial reforms at the country and regional level. The scale and pace of these changes call for systematic assessments of their bearing on the development and integration of financial markets in this region. The purpose of this paper is to investigate the level of financial integration of the equity markets in China and ASEAN4 countries (Indonesia, Malaysia, Philippines, and Thailand) for the period 2004-2014. Design/methodology/approach – The authors use the β and σ convergence, dynamic conditional correlation, and wavelet correlation to assess the degree, trend, and change across different time scales of the integration of China-ASEAN4 equity markets. Using two measures of change in return per unit risk and variance, we assess the difference in diversification benefits between an equity portfolio China-ASEAN4 and China-EU. Findings – The authors find that financial integration across China-ASEAN4 equity markets fluctuated between a moderate level before and after the recent crisis and a higher level during the crisis. The results indicate that investors achieve higher diversification benefits from a cross-industry than a cross-country investment strategy within this region. Research limitations/implications – Future research should investigate whether local factors and existing cultural and political differences explain the weak to moderate level of integration of China and emerging ASEAN equity markets. Practical implications – A good understanding of the degree and evolution of the regional financial integration may be used by investors to allocate capital efficiently when adding ASEAN4 equities to a portfolio of Chinese equities. Social implications – Systematic assessments of the regional financial integration contribute to the effort to mitigate the ensuing cross-border financial contagion during crises. Originality/value – The authors argue that that the increase in correlations of CHINA-ASEAN4 equity markets during the recent crisis does not reflect a permanent shift in the dynamic of the dominant markets in the region. While investors achieve higher diversification benefits from a cross-industry than a cross-country investment strategy within this region, the diversification benefits are lower for long-term than short-term investors.