Long Memory and Asia Crisis: Implication for Capital Controls and Management

• Main Author: LEE, Kuo Chuen David
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 1999
• Subjects: Finance and Financial Management
• Online Access: https://ink.library.smu.edu.sg/lkcsb_research/3376; https://ink.library.smu.edu.sg/context/lkcsb_research/article/4375/viewcontent/library_The_Paper_III.pdf
• Institution: Singapore Management University

“Financial markets are given to excesses and if a boom/bust sequence progresses beyond a certain point, it will never revert to where it came from. Instead of acting like a pendulum, financial markets have recently acted more like a wrecking ball, knocking over one economy after another.” - A testimony before the US House Banking Committee, Sep, 1998. There are three parts to this paper. The first part examines the time series behaviour of the equity indices of ten countries. Using Robinson (1995a)’s modified GPH estimator and Robinson (1994a)’s average periodogram estimator for the differencing parameter, we have detected that not all the financial series exhibit long range dependence. Non-detection of long memory lends support to imposition of policies to block free capital flows. The results suggest that Indonesia has a stronger case to restrict capital flows than Malaysia. In the second part, we attempt to determine the degree of the contagion effects. This has important implications for diversification of portfolio risks as the increased co-dependence of asset prices increases risk in the short-term. Using correlations of equity indices across markets, we can get an indication of the severity of the contagion. The evidence suggests that these effects increased significantly and systematically as the Asian crisis worsen shortly after it started on 2 July 1997. The third part discusses the implications of the results for fund management. We argue that new regulations and hedge fund techniques have contributed to large capital flows that cause severe damage to economies. In the interim period of under-regulation of “leverage” and before the establishment of a new international financial architecture, adopting hedge fund’s market neutral or zero investment techniques may be a way to preserve Asian capital.