Modeling the Fractional Integration in Volatility Between the Greater China Financial Markets

The dynamics of the interrelationships among the financial markets in the Greater China area including Mainland China, Taiwan, and Hong Kong, is a noteworthy issue of economic research. This is not only because the financial markets in this region have grown rapidly over the past decade, but also because of the arguably asymmetric integration of the emerging Chinese economy with advanced countries in the real side of the economy and tight control over financial market. Since its establishment in the early 1990s, the Mainland Chinese stock market has expanded rapidly in terms of capitalization, turnover, and the new listings. Even though the stock markets in the Greater China region have developed independently and with different institutional features, cross-market linkages can be observed in terms of the increasing number of Mainland companies listed in the Stock Exchange of Hong Kong and closer economic ties in the Greater China region. It is believed common factors that affect all economies drive financial integration, while the emerging markets are more likely to be influenced by local events. Recently there have been a number of studies that assess the financial market integration by employing different GARCH models with time-varying conditional correlations. Despite the growing importance of the Greater China stock markets and their dynamic interactions, there have been only a few studies on this issue with a mixed result. Moreover, most of these studies have not analyzed the volatility dynamics of the Greater China stock markets in a multivariate framework, and there is hardly any extensive discussion of the presence of volatility persistence in these markets. This would create potential model misspecification and may generate biased results. In this study we employ a multivariate framework that incorporates the features of asymmetries, persistence, and time-varying correlations to examine the volatility dynamics of the Greater China stock markets (Shanghai A- and B-shares, Shenzhen A- and B-shares, Taiwan, and Hong Kong). The results indicate that the B-share markets do not exhibit significant asymmetric volatility (“leverage effect”), and return volatility in the A-share market is substantially higher than that in the B-share market before April 1997. Since then, this result is reversed. There is strong evidence of volatility persistence in all the markets, which is robust to changes in model specification. The Greater China stock markets apparently share a common degree of persistence (fractional integration) in volatility. Moreover, the Shenzhen and Shanghai stock exchanges are positively but not perfectly correlated with each other, with the strength of correlation increasing after the late nineties. Their correlations with the Hong Kong and Taiwan markets are much weaker, and they do not display any clear trends. These findings have important implications for hedging and portfolio management and diversification