The Dynamic Linkage between the Exchange Rate and Stock Index-Evidence from Taiwan and Korea before and after Financial Crisis of 2008
Date Issued
2015
Date
2015
Author(s)
Chen, Ren-Hao
Abstract
The main purpose of this paper is to investigate the dynamic linkage between stock price index and exchange rates from Taiwan and Korea, before and after the 2008 financial crisis. Taiwan and Korea are similar in industrial as well as stock market structure. Generally speaking, both develop high technology as main industry, and foreign capital all accounts for 30 to 40% in total stock market value. Besides, they enforced financial liberalization during 1980s and 1990s, including the deregulation of international capital movement and the cutting down control of exchange rate, both of which are the major sources for the linkage between stock and foreign exchange markets. During the process of financial liberalization, Taiwan has lifted little regulation of international capital movement and control of exchange rate, and even to date; conversely, Korea is the opposite. Taiwan could be viewed as conservative and stable, while Korea could be regarded as active and prompt. The former keeps it in a safer position from global financial crisis, though bearing a lower rate of economic growth; the latter enjoys prosperous economy, but exposes itself to foreign condition, resulting in the increasing fluctuations of stock and foreign exchange markets. As for the methodology, first of all, ADF unit root test is performed to ensure that all variables are stationary. Second, Engle-Granger cointegration test is conducted, once the cointegration relation is found, the vector error correction model (VECM) is adopted to analyze short-term as well as long-term relations among variables. However, the vector autoregression(VAR) method is applied instead if the cointegration test was rejected. Finally, the impulse response function and forecast error variance decomposition help to explore how much time would it take from the beginning of shocks to convergence. The empirical result shows that there’s no cointegration before and after the 2008 financial crisis for Taiwan, and so is Korea before the 2008 financial crisis. However, in the aftermath of the crisis, Korea starts to show cointegration relation, meaning a long-term linkage among variables. And the results may be attributed to the interruption of foreign exchange market by central bank in Taiwan, who always deems stability of exchange rate as its top priority. Furthermore, regulation of international capital movement still maintain at a highly strict level. On the other hand, for Korea, though till the end of 1990s, it had turned into floating exchange rate regime and abolished control of international capital movement, the issuance of Monetary Stabilization Bonds and domination of local financial institutes by foreign capital contributed to no cointegration. After the crisis, Korea let its currency depreciate as it should be and supported liquidity of foreign exchange, simultaneously, the law of Financial Investment Services and Capital Market Act was enforced in 2009, these all together brought cointegration. All in all, both of the countries had established the foundation of financial liberalization at the same periods, nevertheless, owing to different attitudes, one conservative, and the other one active, they had put themselves into different predicaments while encountered global economic crisis. Last but not least, this thesis aims at finding the balance between Taiwan and Korea by means of comparing the policies they had implemented.
Subjects
Stock Price Index
Exchange Rate
Unit Root Test
Cointegration
VAR
VECM
Impulse Response Function
The 2008 Financial Crisis
SDGs
Type
thesis