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International Review of Financial Analysis 17 (2008) 571 591

Financial crisis and stock market efficiency: Empirical evidence from Asian countries
Kian-Ping Lim 1 , Robert D. Brooks , Jae H. Kim
Department of Econometrics and Business Statistics, Monash University, P.O. Box 1071, Narre Warren, VIC 3805, Australia Received 17 November 2006; received in revised form 31 January 2007; accepted 4 March 2007 Available online 15 March 2007

Abstract This paper empirically investigates the effects of the 1997 financial crisis on the efficiency of eight Asian stock markets, applying the rolling bicorrelation test statistics for the three sub-periods of pre-crisis, crisis, and post-crisis. On a country-by-country basis, the results demonstrate that the crisis adversely affected the efficiency of most Asian stock markets, with Hong Kong being the hardest hit, followed by the Philippines, Malaysia, Singapore, Thailand and Korea. However, most of these markets recovered in the post-crisis period in terms of improved market efficiency. Given that the evidence of nonlinear serial dependencies indicates equilibrium deviation resulted from external shocks, the present findings of higher inefficiency during the crisis are not surprising as in the chaotic financial environment at that time, investors would overreact not only to local news, but also to news originating in the other markets, especially when the news events were adverse. 2007 Elsevier Inc. All rights reserved.
JEL classification: G14; G15 Keywords: Market efficiency; Asian crisis; Stock market; Nonlinear serial dependence; Bicorrelation

1. Introduction The weak-form version of the Efficient Markets Hypothesis (EMH) has been subjected to years of rigorous empirical testing across national stock markets. However, the bulk of the literature focused mainly on testing whether the stock market is efficient or inefficient for the

Corresponding author. E-mail address: robert.brooks@buseco.monash.edu.au (R.D. Brooks). 1 Labuan School of International Business and Finance, Universiti Malaysia Sabah, P.O. Box 80594, 87015 F.T. Labuan, Malaysia. 1057-5219/$ - see front matter 2007 Elsevier Inc. All rights reserved. doi:10.1016/j.irfa.2007.03.001

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selected sample period, using statistical tests such as the serial correlation tests, runs test, variance ratio tests, unit root tests and spectral analysis. Though the phenomenal growth in this body of literature could be largely attributed to the interest of financial economists and investment communities on the predictability of stock prices, another often cited reason for conducting efficiency testing is its implication for the guidance of policy. Specifically, an efficient market is one in which stock prices fully reflect all available information thereby leading to efficient allocation of scarce capital resources.2 Hence, market inefficiency provides an economic foundation for public policy interventions in stock markets (see Fortune, 1991). Mookerjee and Yu (1999) argued that if the problem of inefficiency is not rectified by the authority, it could seriously limit the ability of the stock market to allocate funds to the most productive sectors of the economy and potentially hamper long-term growth (see also Kavussanos & Dockery, 2001 for similar argument).3 However, the verdict proclaimed based on the full sample analysis in conventional efficiency studies does not provide much useful input to market regulators for making informed decisions since less effort has thus far been given to the underlying factors that lead to markets being efficient or inefficient. As noted by Antoniou, Ergul, and Holmes (1997), an understanding of the contributing factors would help to determine the appropriate regulatory framework for the establishment of efficiently functioning stock markets. The 1997 Asian financial crisis has prompted policy makers to reconsider their commitment to the liberalization of capital flows. In fact, Malaysia went ahead with the implementation of wideranging capital control measures on 1 September 1998 aimed at ending speculation on the Malaysian currency. Though the literature on the Asian financial crisis is extensive, one facet of this crisis that did not receive much attention is its impact on stock market efficiency.4 The massive falling of stock prices in several Asian countries during the late 1997 was often quoted, with no formal analysis, as compelling evidence against stock market efficiency. This issue was only taken up recently by Kim and Shamsuddin (2006), Cheong, Nor, and Isa (2007) and Hoque, Kim, and Pyun (in press). Given the significant gap in extant literature, the objective of the present paper is to empirically investigate the effects of the Asian financial crisis on the efficiency of selected Asian stock markets, using the rolling bicorrelation test statistic advocated by Lim and Brooks (2006) and Lim (2007). This study extends the existing literature in four significant aspects. Firstly, in most of the earlier studies as cited in the next section, departure from market efficiency is assumed to take the form of linear correlations. However, the lack of autocorrelation does not necessarily imply efficiency as returns series can be linearly uncorrelated and at the same time nonlinearly dependent. Hence, incorrect inference on efficiency could be made when the underlying series have zero autocorrelation yet possess predictable nonlinearities in mean. On the other hand, when significant autocorrelation is detected, there is always a worry that the verdict of inefficiency would be too harsh due to the possibility that the linear predictability could be spurious as a result
2 Harrison and Paton (2004: 220) noted that evidence of stock market efficiency is helpful in deciding whether transition economies in Europe are able to satisfy the key criterion of having a functioning market economy as stipulated in the Copenhagen Criteria for European Union membership. The authors argued that an efficient stock market encourages efficiency in the allocation of resources and would better equip an economy to cope with the competitive pressure within the Union. 3 In a related paper, Cioppa (2005) argued that the EMH is an indispensable and very useful tool for regulation in countries such as the United States and Britain as the theory provides a clear and relatively simple prescriptions for regulation. 4 This applies equally to the foreign exchange market, with Jeon and Seo (2003), Aroskar, Sarkar, and Swanson (2004) and Phengpis (2006) representing the small amount of literature available.

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of thin trading problem (for details, see Lim & Brooks, 2006; Lim, Brooks, & Hinich, 2006). This issue is taken care of in the present research framework since the bicorrelation test statistic of Hinich (1996) is designed to detect the presence of nonlinear serial dependencies in time series data. This nonlinearity test is the preferred choice because it has good sample properties over short horizons of data (Hinich, 1996; Hinich & Patterson, 1995, 2005) and the test suggests an appropriate functional form for a nonlinear forecasting equation (Brooks & Hinich, 2001). Secondly, another limitation of those earlier studies, with the exception of Kim and Shamsuddin (2006) and Cheong et al. (2007), is the implicit assumption of a fixed level of market efficiency throughout the estimation period, suggesting that the movement towards efficiency will take the form of a discrete change in the underlying parameters at the predetermined breakpoint. However, it is reasonable to expect market efficiency to evolve over time, and this dynamic characteristic could not be captured in arbitrarily chosen sub-samples or other non-overlapping intervals. In order to incorporate the possibility of a smooth and continuous process, a number of recent studies employed time-varying parameter model or rolling window approach, and their results reveal the evolution of market efficiency over time in all the stock markets under study (for a review, see Lim, Books, & Hinich, 2006). Due to this concern, the empirical analysis in this paper computes the bicorrelation test statistic in a rolling window framework to detect the evolving nature of nonlinear predictability and hence changing degree of market efficiency over time. Thirdly, given that the rolling window approach is able to detect periods of efficiency/ inefficiency, the relative efficiency of stock markets can easily be assessed by comparing the total time periods these markets exhibit significant nonlinear serial dependence (see Lim, 2007; Lim & Brooks, 2006). As such, it is possible to conduct a comparative analysis not only within a particular market for pre-crisis, crisis and post-crisis periods, but also across those Asian stock markets. Fourthly, Lim, Hinich, and Brooks (2006) conjectured that the presence of nonlinear serial dependency structures is due to the slow market responses to unexpected shocks. The traumatic collapse of stock prices following massive depreciation of exchange rates during the Asian crisis gave credence to the view that investors were swamped by panic, and this adversely affected the market's ability to price stocks efficiently.5 Hence, the 1997 crisis presents a unique setting to gauge investors' reactions during turbulent periods. The plan of this paper is as follows. Section 2 reviews those earlier studies that have investigated the possible contributing factors of market efficiency/inefficiency. Section 3 then discusses the rolling bicorrelation test statistic adopted in the empirical analysis. Description of the data and discussion on the statistical results are provided in Sections 4 and 5 respectively. The final section concludes the paper. 2. A review of related literature As noted earlier, the EMH can provide useful input to market regulators, and this prompted a number of studies to take their investigation a step further by examining the impact of some postulated factors on the degree of market efficiency in a specific market. For instance, given that the regulatory framework may impact on the efficiency of markets, Antoniou et al. (1997) argued that it is necessary to examine efficiency at different stages of development to reflect changes in
For instance, Radelet and Sachs (1998) emphasized the role of financial panic as an essential element of the Asian crisis. According to these authors, certain policy choices and events along the way exacerbated the panic and unnecessarily deepened the crisis. However, there were divergent views on the causes of the Asian crisis, and it is not the objective of the present paper to dwell on this unresolved debate.
5

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market regulations. Using daily data on the Istanbul Stock Exchange (ISE) Composite Index, the authors investigated efficiency on a yearly basis for the period from 1988 to 1993. Their results show that changes in the regulatory structure from late 1989 have led the ISE to become efficient since the year 1991. Hence, these authors concluded that an efficient market is brought about by providing a regulatory framework that encourages participation in the market, removes institutional restrictions on trading, and ensures investors have access to high quality and reliable information. Groenewold, Tang, and Wu (2003), Groenewold, Wu, Tang, and Fan (2004) postulated that changes in the regulations governing the direct involvement of banks in the stock market would have significant effects on market efficiency given the fact that Chinese banks traditionally played a dominant role in their country's financial system. To address this question empirically, the authors examined market efficiency over three different sub-periods in which banks were subjected to different regulations. The statistical results support their conjecture, in particular, market efficiency suffers when banks were excluded from the stock market during the sub-period of 7/1/199612/31/1999, but there is improvement in efficiency when banks were readmitted during 1/1/20003/29/2001. In the wake of the movement towards financial liberalization in emerging markets, some researchers explored the issue of whether the opening of these markets to foreign investors has caused stock markets to become more efficient, by examining the degree of efficiency before and after the date of liberalization. Groenewold and Ariff (1998) noted that an improvement in market efficiency is an important aim of such policy initiative. This inquiry is even more pertinent after the 1997 financial crisis as there has been much discussion in the policy circles to reverse the previous liberalization measures by imposing some forms of controls on capital flows (see Kim & Singal, 2000a,b). While there is no formal theoretical work studying the effect of financial liberalization on stock market efficiency, most of the empirical studies were carried out under the rubric of the EMH. Specifically, it was hypothesized that as stock markets are liberalized and made more open to the public (both domestic and international investors), prices should reflect the increased availability of information and become more efficiently priced. However, the empirical evidence on this subject matter is rather inconclusive. Kim and Singal (2000a,b) and Fss (2005) found that, in general, there is an improvement in market efficiency following the opening of stock markets in emerging economies. The statistical results in Basu, Kawakatsu, and Morey (2000) weakly support the hypothesis that financial liberalization has made emerging markets more informationally efficient. In contrast, Groenewold and Ariff (1998), Kawakatsu and Morey (1999a,b) and Laopodis (2003, 2004) reported that their sampled markets are weak-form efficient even before actual market opening date. On the other hand, Maghyereh and Omet (2002) concluded that market liberalization has no discernible effect on the degree of efficiency, as the Amman Stock Exchange remains inefficient after liberalization. The occurrence of market crash or financial crisis is another possible contributing factor of market inefficiency. However, there is a lack of research on the impact of financial crisis stock market efficiency. Only lately, Hoque et al. (in press) examined the weak-form efficiency of eight emerging Asian stock markets using variance ratio tests for the pre-crisis (19901997) and postcrisis (19982004) periods. Their results show that the crisis has no significant effect on the degree of efficiency with six of the Asian markets (Hong Kong, Indonesia, Malaysia, Philippines, Singapore and Thailand) remain inefficient even after the crisis, while the opposite occurs for Korea. Taiwan is the only market that has recorded improved efficiency from the pre-crisis to post-crisis period. Using new multiple variance ratio tests, Kim and Shamsuddin (2006) also found that the Asian crisis does not coincide with a significant change in the level of market efficiency, both for the efficient (Hong Kong, Japan, Korea and Taiwan) and inefficient group

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(Indonesia, Malaysia and Philippines), with Singapore and Thailand being the exceptional cases that attain efficiency after the crisis. In an exclusive study on the Malaysian stock market, Cheong et al. (2007) divided the sample data into pre-crisis (1/1/199112/31/1/996), crisis (1/1/19978/ 31/1998), USD pegged (9/1/199812/31/2000) and post-crisis (1/1/20014/14/2005) periods. Using the rolling Hurst exponents proposed by Cajueiro and Tabak (2004a,b), the authors reported that the highest inefficiency is during the crisis periods, followed by pre-crisis, post-crisis and USD pegged period. 3. The rolling bicorrelation test statistic This section provides a brief description of the bicorrelation test statistic (henceforth denoted as H statistic) that was designed to detect the presence of nonlinear serial dependencies in time series data. The full theoretical derivation and some Monte Carlo evidence on the small sample properties of the test statistic are given in Hinich (1996) and Hinich and Patterson (1995, 2005).6 Let the sequence {y(t)} denote the observed sampled data process, where the time unit, t is an integer. In the rolling window approach, the H statistic is computed for the first window of a specified length, and then the sample is rolled one point forward eliminating the first observation and including the next one for re-estimation of the H statistic. This process continues until the last observation is used. In other words, the start date and end date successively increase by one observation. For instance, in a fixed-length rolling window of 50 observations, the first window starts from day 1 and ends on day 50, the second window comprises observations running from day 2 through day 51, and so on. The last window is built with the last 50 observations. The computed H statistic at each rolling window reflects the changing nonlinear behaviour of the returns generating process due to the arrival of new information or other underlying factors, and hence captures the evolving dynamics of market efficiency over time. The data in each time window is standardized to have a sample mean of zero and a sample variance of one by subtracting the sample mean of the window and dividing by its standard deviation in each case. Define Z(t) as the standardized observations that can be written as: Z t yt my sy 1

for each t = 1,2,n where my and sy are the sample mean and sample standard deviation of the window. The null hypothesis for each time window is that the transformed data {Z(t)} are realizations of a stationary pure white noise process. Under the null hypothesis, the bicorrelations CZZZ (r,s) = E[Z(t)Z(t + r)Z(t + s)] are all equal to zero for all r, s except when The alternative hypothesis is that the process in the window has some non-zero bicorrelations in the set 0 b r b s b L where L is the number of lags. In other words, if there exists third-order nonlinear dependence in the data generating process, then CZZZ (r,s) 0 for at least one pair of r and s value. The H statistic and its corresponding distribution are: H
L X s1 X s 2 r 1

G 2 r ; s v2 LL1=2

Readers are advised to consult Lim, Brooks, and Hinich (2006) for detailed discussion on issues and empirical implementations related to the test statistic.

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1

where Gr; s ns2 CZZZ r; s and the (r,s) sample bicorrelation coefficient is: CZZZ r; s ns1
n s X t 1

Z t Z t rZ t s

for 0VrV s:

The number of lags L is specified as L = nb with 0 b b b 0.5 where b is a parameter under the choice of the user. All lags up to and including L are used to compute the bicorrelations in each window. Based on the results of Monte Carlo simulations, Hinich and Patterson (1995, 2005) recommended the use of b = 0.4 which is a good compromise between (1) using the asymptotic result as a valid approximation for the sampling properties of H statistic for moderate sample sizes, and (2) having enough sample bicorrelations in the statistic to have reasonable power against non-independent variates. Given that the rejection of the null of pure white noise can be due to non-zero correlations (linear dependence) or non-zero bicorrelations (nonlinear dependence), data pre-whitening is necessary prior to the application of the bicorrelation test in order to remove any linear structure from the data, so that any remaining serial dependence must be due to a nonlinear data generating mechanism. The linear filtering procedure also serves to address the concern of spurious autocorrelation generated by thin trading in those conventional efficiency studies. Specifically, Hong and Lee (2005) argued that since one can never be sure on the degree of significant autocorrelation that could be attributed to thin trading, an alternative approach would be to remove all linear serial correlations from the data and determine whether stock returns still contain predictable nonlinearities. In this study, the autocorrelation structure in each window is filtered out by an autoregressive AR(p) fit. It is worth highlighting that the AR fitting is employed purely as a prewhitening operation, and not to obtain a model of best fit. As noted earlier, the portmanteau bicorrelation test is then applied to the residuals of the fitted model of each window, and any further rejection of the null hypothesis of pure white noise is due only to significant H statistic. Another element that must be decided upon is the choice of the window length. In the present context, the larger the window length, the larger the number of lags and hence the greater the power of the test, but this would average the test statistics across all the data and preclude the detection of episodic transient nonlinear dependence within the data. As mentioned in Section 1, the bicorrelation test has good sample properties over short horizons of data (Hinich, 1996; Hinich & Patterson, 1995, 2005), and most of the empirical applications have used window length of less than 50 observations (see references cited in Lim, Brooks, & Hinich, 2006; Lim, Hinich, & Brooks, 2006). Hence, the present study computes the time-dependent H statistic in a rolling window of 50 observations. This window length is sufficiently long enough to validly apply the test and yet short enough to be able to pinpoint the arrival and disappearance of transient dependencies. To offer further improvement to the size of the test in small samples, resampling with replacement that satisfies the null hypothesis is used to determine a threshold level for the p-value of the H statistic. 4. The data To address the impact of the Asian financial crisis on market efficiency, one has to first identify the crisis period. Karolyi (2002) highlighted the difficulty of pinpointing the precise start of the crisis, but the devaluation of the Thai baht in July 1997 is widely regarded as the triggering event. According to International Monetary Fund (1998: 16), the Asian crisis started when the Bank of Thailand announced a managed float of the currency on 2 July 1997, effectively devaluing the

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baht by 15% in onshore markets and by 20% in offshore markets. In what appeared to be a local currency crisis in Thailand quickly escalated into full-blown financial turmoil, spreading to other Asian countries like Indonesia, Korea, Malaysia and the Philippines, with massive depreciations of local currencies and the collapse of stock markets. Empirically, the selection of 2 July 1997 in the present study to mark the beginning of the crisis is consistent with Nagayasu (2001), Karolyi (2002), Ratanapakorn and Sharma (2002), Sander and Kleimeier (2003) and Lin (2006). To determine the end of the Asian financial crisis is even more difficult and it has become an arbitrary choice in the literature. Following Karolyi (2002), this study defines December 1998 as the end of the crisis, in which most of the Asian economies had recovered to pre-crisis level of GDP and their respective currencies almost ended the depreciation spree and regained stability. The present paper focuses on eight Asian stock markets and the indices at daily frequency for these markets are collected as follows: Hong Kong (Hang Seng Index) Indonesia (Jakarta SE Composite), Korea (Korea SE Composite), Malaysia (Kuala Lumpur Composite), Philippines (Philippines SE Composite), Singapore (Strait Times Index), Taiwan (Taiwan SE Weighted) and Thailand (Bangkok S.E.T.). All the closing prices obtained from Datastream are denominated in their respective local currency units. For subsequent analysis, the data are transformed into a series of continuously compounded percentage returns by taking 100 times the log price relatives, i.e. rt = 100 * ln( pt/pt1), where pt is the closing price of the index on day t. Fig. 1 provides graphical plots for the returns series of all selected Asian indices covering the sample period 1/2/ 1992 to 12/31/2005. The shaded region in the figure corresponds to the crisis period. In most cases, the time series show distinctive spikes during the Asian crisis. It appears from the visual inspection that the series exhibit volatility clustering, in which large changes are followed by large changes of either sign, and small changes tend to be bunched together. 5. Empirical results 5.1. Tracking the evolution of stock market efficiency The H statistic for each time window is computed using the T23 program coded in FORTRAN.7 The program transforms the H statistic obtained from Eq. (2) into a percentile (i.e. one minus the pvalue) using the cumulative distribution function of the test statistic under the null hypothesis. For example, if the percentile for a particular window is 0.95, then the test statistic has a p-value of 0.05. It is this percentile that is reported as the H statistic for each window, but the p-value is used to summarize the results of the test statistic. Specifically, if the p-value for the H statistic in a time window is deemed small by the analyst, then the null hypothesis of pure white noise can be rejected. In this case, the significant H statistic indicates the presence of nonlinear serial dependence and hence market inefficiency for that particular window. In the present study, the threshold level (or cut-off point) for the p-value of the H statistic is set at 5%. As noted earlier, resampling with replacement is used to determine the threshold level that has a test size to be 5%. Specifically, a window is defined as significant when the p-value of the H statistic is less than or equal to the bootstrapped threshold drawn from 10,000 replications that corresponds to the earlier specified nominal threshold level of 5%. Since it is impossible to report the computed H statistic for each rolling time window, the results are best communicated through graphical depiction, as depicted in Fig. 2 for all Asian indices under study, covering the sample period 1/2/1992 to 12/31/2005. The vertical axis shows the p-values of the H statistic in each rolling time window, while the horizontal axis is labelled with
7

This program written by Melvin J. Hinich can be downloaded from http://www.gov.utexas.edu/hinich/.

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Fig. 1. Time series plots for returns series of Asian stock market indices. Note: Shaded region corresponds to the crisis period (7/2/1997-12/31/1998).

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Fig. 2. Time series plots for p-values of rolling H statistics over full sample period. Notes: Shaded region corresponds to the crisis period (7/2/1997-12/31/1998); Dotted horizontal line is the boat strapped threshold level for the p-value of H statistic.

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the starting dates of the time window. The bootstrapped threshold level for the p-value is plotted as horizontal dotted lines parallel to the X-axis. Graphically, a time window is significant if the p-value lies below or on the threshold line, suggesting market inefficiency during that particular time period. Fig. 2 clearly shows that all the Asian stock markets enjoyed long periods of efficiency with returns series follow a pure white noise process, only to be interspersed with brief periods of nonlinear departure from market efficiency. In other words, there is no clear trend towards higher efficiency as predicted by the classical EMH in all country indices under study, consistent with the findings reported in Lim and Brooks (2006) and those earlier studies cited in their study. Given that predictability is plotted as a function of time in the time-varying parameter model or rolling window approach, it is possible to gain further insight into the causes that contribute to market inefficiency. For instance, after the periods of inefficiency were identified, Rockinger and Urga (2000) conducted careful inspection of anecdotal evidence from stock market characteristics, economic and political events. Li (2003) used non-quantifiable changing characteristics of the markets such as market liquidity, information disclosure mechanism and regulation enforcement at different points of time to infer on the inefficiency of the Chinese stock markets. Jefferis and Smith (2005) related the changing degree of weak-form efficiency at different stages of development to market turnover, capitalisation and institutional characteristics of the stock markets. Costa and Vasconcelos (2003) identified the movements of Hurst exponents towards 0.5 as a consequence of the economic plans adopted by the government, i.e. the Cruzado plan in February 1986, Collor Plan in March 1990, and Real Plan in July 1994. On the other hand, the nonlinear dependency structures in Brooks, Hinich, and Molyneux (2000) are related to two important events that occurred during their sample period-widespread upsets in the currency markets and a change in U.S. accounting procedures that affected U.S. firms with business abroad. In a similar vein, Lim, Hinich, and Brooks (2006) were able to identify major political and economic events that contributed to the short bursts of nonlinear behaviour in the Malaysian stock market. The present paper focuses squarely on the issue of whether the 1997 financial crisis is largely responsible for the inefficiency of those Asian stock markets. The shaded region in Fig. 2 corresponds to our earlier defined crisis period (7/2/199712/31/1998). As observed graphically, there was significant departure from inefficiency during this turbulent period for all markets. To shed further light on this issue, Table 2 reports the total number of significant H windows that occurred during the crisis period. Following the approach advocated by Lim and Brooks (2006) and Lim (2007) for assessing the relative efficiency of stock markets, Hong Kong appears to be the most efficient over the 14 years full sample period, followed by Korea and Taiwan, while Malaysia is at the tail end of the ranking list. However, in the case of Hong Kong, there is a high concentration of those detected inefficiency in the crisis period, accounting for 51.50% of the total significant H windows in the 14 years' history of the exchange. The crisis is also responsible for a large portion of inefficiency in the Philippines, Taiwan and Malaysia. Surprisingly, the results reveal that the 1997 crisis does not exert a large impact on the efficiency of Indonesian stock market, though her economy was widely acknowledged as one of the hardest hit by this financial turmoil (Table 1). 5.2. A closer look at the Asian financial crisis This section takes the analysis further by examining the efficiency for three sub-periods: precrisis, crisis and post-crisis. Since the crisis period has been identified earlier, it is easier to define the remaining two sub-periods. In order to ensure a fair comparison, the pre-crisis and post-crisis corresponds to 1/1/19967/1/1997 and 1/1/19996/30/2000 respectively, such that each subperiod has roughly equal number of observations. The descriptive statistics for the Asian returns

K.-P. Lim et al. / International Review of Financial Analysis 17 (2008) 571591 Table 1 Rolling bicorrelation test results for full period Total number of rolling time windows in full period Hong Kong Indonesia Korea Malaysia Philippines Singapore Taiwan Thailand 3602 3602 3602 3602 3602 3602 3602 3602 Total number of significant H windows in full period 266 536 273 555 453 539 280 390 Total number of significant H windows in crisis period 137 45 49 113 118 76 70 74

581

Percentage of significant H windows in crisis period as per full period (%) 51.50 8.40 17.95 20.36 26.05 14.10 25.00 18.97

series over these three sub-periods are provided in Table 2. In the period before crisis, the sample means for all indices are positive except Korea and Thailand, with Taiwan the best performer achieving average returns of 0.14%. However, market performance was adversely affected by this crisis, with all indices recorded negative mean returns. As stock prices across the region ended
Table 2 Descriptive statistics for returns series in pre-crisis, crisis and post-crisis periods Mean Maximum Minimum Standard deviation 1.0872 0.9071 1.2795 0.8526 1.0710 0.8242 1.2724 1.4962 Skewness Kurtosis JB normality (p-value) 0.0000 0.0000 0.0272 0.0000 0.0000 0.0000 0.0000 0.0000

Pre-crisis period (1/1/19967/1/1997) Hong Kong 0.1049 4.3692 Indonesia 0.0901 3.1733 Korea 0.0389 4.3753 Malaysia 0.0206 2.6754 Philippines 0.0209 4.8968 Singapore 0.0009 2.5707 Taiwan 0.1428 4.0565 Thailand 0.2264 4.9321 Crisis period (7/2/199712/31/1998) Hong Kong 0.1055 17.2471 Indonesia 0.1553 13.1277 Korea 0.0761 10.0238 Malaysia 0.1557 20.8174 Philippines 0.0913 9.6658 Singapore 0.0824 14.8685 Taiwan 0.0871 5.5462 Thailand 0.1003 11.3495 Post-crisis period (1/1/19996/30/2000) Hong Kong 0.1214 5.0383 Indonesia 0.0659 10.7074 Korea 0.0968 7.6972 Malaysia 0.0900 5.8505 Philippines 0.0638 5.3324 Singapore 0.0974 5.5240 Taiwan 0.0647 8.5198 Thailand 0.0226 10.2286

7.5940 4.2354 4.2047 3.3288 4.6484 4.3530 6.9757 6.1840 14.7347 12.7321 11.6006 24.1534 9.7442 9.6719 6.8067 10.0280 8.9390 5.4355 12.3675 6.2295 5.5274 9.0950 6.7745 7.3455

0.9148 0.3277 0.0997 0.3505 0.0623 0.2836 0.4931 0.0111

9.9831 5.4830 3.6337 5.1107 5.8702 5.0157 6.7158 4.8203

2.9020 2.9219 3.1597 3.5323 2.4207 2.2982 1.6188 2.7480

0.4364 0.2374 0.2722 0.5600 0.1600 0.8548 0.0877 0.7813

9.0997 6.1046 4.1902 15.3930 5.0712 9.7906 4.5829 5.0178

0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000

1.8263 1.9978 2.6098 1.6203 1.4543 1.5987 1.7416 2.1495

0.3411 0.6813 0.2862 0.0777 0.3126 0.4213 0.2537 0.6080

4.8379 5.6608 4.1612 4.8094 4.8964 6.3211 5.6952 5.8054

0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000

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their downward trend in 1998, most markets regained profitability in the subsequent sub-period, with the exception of the Philippines and Thailand. Notably, after two consecutive periods of negative average returns, Korea managed to rebound strongly in the post-crisis period, but Thailand was not able to come out from the negative zone. During the 1997 crisis, stock markets throughout the world, especially in Asia, exhibited tremendous volatility. This is clearly evidenced from Table 2, in which the standard deviation of returns series for all markets recorded a sharp increase from pre-crisis to crisis period. According to International Monetary Fund (1998: 4), volatility for Asian markets during the year 1997 reached levels in excess of that in Latin American markets at the peak of the 19941995 Mexican crisis. The report claimed that this is closely related to the volatility in exchange markets and to uncertainty generated by large exchange rate depreciations in the face of significant unhedged foreign currency borrowing. On the other hand, Kaminsky and Schmukler (1999) noted that daily changes in stock prices of about 10% became commonplace in the chaotic financial environment of Asia in 19971998. In their study, the authors found that a substantial portion of the large movements during the crisis cannot be explained by economic or political news but apparently driven by herding. When news releases do affect largest daily stock price changes, the ones that matter the most are news about agreements with international organizations and credit rating
Table 3 Rolling bicorrelation test results for pre-crisis, crisis and post-crisis periods Total number of rolling time windows Pre-crisis period (1/1/19967/1/1997) Hong Kong 342 Indonesia 342 Korea 342 Malaysia 342 Philippines 342 Singapore 342 Taiwan 342 Thailand 342 Crisis period (7/2/199712/31/1998) Hong Kong 342 Indonesia 342 Korea 342 Malaysia 342 Philippines 342 Singapore 342 Taiwan 342 Thailand 342 Post-crisis period (1/1/19996/30/2000) Hong Kong 341 Indonesia 341 Korea 341 Malaysia 341 Philippines 341 Singapore 341 Taiwan 341 Thailand 341 Total number of significant H windows 1 48 32 65 30 31 70 52 Percentage of significant H windows (%) 0.29 14.04 9.36 19.01 8.77 9.06 20.47 15.20

137 45 49 113 118 76 70 74

40.06 13.16 14.33 33.04 34.50 22.22 20.47 21.64

5 34 35 62 35 79 29 25

1.47 9.97 10.26 18.18 10.26 23.17 8.50 7.33

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agencies. Moving beyond the basic mean and standard deviation measurements to higher-order moments, all the returns series exhibited non-zero skewness levels and excess kurtosis, and hence it is not surprising that the Jarque-Bera (JB) test strongly rejects the null of normality for all markets in the three sub-periods. The subsequent analysis extends the work of Cheong et al. (2007) who assessed the relative efficiency of Malaysian stock market in four sub-periods: pre-crisis, crisis, USD pegged and postcrisis. Following the framework of Cajueiro and Tabak (2004a,b), these authors compared the efficiency of the selected sub-periods using the median of those computed rolling Hurst exponents. The extensions in the present paper are threefold: first, the scope of the analysis is wider covering eight Asian stock markets; second, the focus is on the nonlinear departure from market efficiency; third, the indicator for assessing relative efficiency is the percentage of time windows that the market departs from efficiency, as Lim (2007) argued that the popular median measure defeats the fundamental objective of using a rolling window approach. Table 3 presents the results of the rolling bicorrelation test for the sub-periods of pre-crisis, crisis and post-crisis, and these were summarized in Fig. 3 to facilitate comparison. On a country-by-country basis, the findings clearly demonstrate that the 1997 crisis adversely affected the efficiency of most Asian stock markets, with the exception of Indonesia and Taiwan. Hong Kong is the worst hit by the crisis in terms of market efficiency, with the percentage of significant H windows increasing dramatically from 0.29% to 40.06%. This is followed by the Philippines, Malaysia, Singapore, Thailand and Korea. In 1998, most economies have regained stability, and this positive development has restored investors' confidence, contributing to an increased efficiency in the post-crisis period for most stock markets except Singapore. Once again, Hong Kong is in the limelight with the strongest turnaround. Trailing behind are the Philippines, Malaysia, Thailand, Taiwan, Korea and Indonesia. The statistical significance in the difference between two proportion estimates in successive sub-periods can be formally tested using the following test statistic8: p1 p2 z r   1 1 p 1 p n n 1 2 4

is the pooled proportion estimate, where p i is the sample proportion estimate for sub-period i, p and ni is the sample size (in this case, the number of rolling windows) for sub-period i. The statistic z approximately follows the standard normal distribution under the null hypothesis that the two population proportions are equal. The results in Table 4 reinforce our earlier conclusion that the Asian crisis has adversely affected the efficiency of Hong Kong, the Philippines, Malaysia, Singapore, Thailand and Korea, as their proportion estimates between the two successive pre-crisis and crisis sub-periods are statistically different at least at the 5% level of significance. In addition, the test statistics are significant at 1% level for Hong Kong, Philippines, Malaysia, Thailand and Taiwan, confirming the improvement in market efficiency for these markets after the crisis. It is interesting to note that our findings for Malaysia are consistent with those reported by Cheong et al. (2007), in which the highest inefficiency occurs during the crisis, followed by pre-crisis and post-crisis period. The present framework also permits one to compare the relative efficiency of these Asian stock markets in a specific sub-period. For instance, though Hong Kong is the most efficient over the 14 years full sample period, they are the most inefficient
The authors thank an anonymous referee for the suggestion to conduct a formal test to reinforce the results obtained in Table 3.
8

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Fig. 3. Percentage of significant rolling H windows in pre-crisis, crisis and post-crisis periods.

market during the crisis period with Indonesia emerging as the unexpected leader. Possible reasons for the higher inefficiency in Hong Kong are explored at the end of this sub-section. In a recent paper, Lim, Hinich, and Brooks (2006) conjectured that the presence of nonlinear serial dependency structures is due to the slow market responses to unexpected shocks, in which the full impact is only grasped by investors over an extended period of trading days before the market typically settles on a new equilibrium price. Using the Hinich (1996) bicorrelation test statistic in a non-overlapped moving sub-samples setting, the authors were able to identify those time periods with significant nonlinear dependence in the intraday ten-minute returns series of the Malaysian stock market. The next stage of event-matching found that the Russian crisis, the unorthodox capital control measures and the Brazilian crisis were those real shocks that have unsettled the domestic market and caused large deviations from equilibrium. Furthermore, their results reveal that the month of August 1998 experienced frequent bursts of nonlinear structures which could be attributed to the deepening crisis in the international financial markets, lingering weakness of the Malaysian currency, depressed investor sentiment in the domestic stock market, and increased political tension in the country at that time. However, these authors noted that the factors that shook the market need not be news announcement in the media. It could be due to,
Table 4 Statistical test for the equality of the population proportions in two successive sub-periods Pre-crisis vs. crisis periods Hong Kong Indonesia Korea Malaysia Philippines Singapore Taiwan Thailand 12.9578 0.3347 2.0118 4.1830 8.1714 4.7365 0.0000 2.1699 Crisis vs. post-crisis periods 12.4267 1.3022 1.6168 4.4478 7.5968 0.2948 4.4405 5.3100

Notes: The entries are the test statistics obtained from Eq. (4). and denote significance at the 5% and 1% levels respectively.

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among others, rumours, speculations, expectations, or worries prevail in the investment communities. As discussed earlier, the efficiency of the Asian stock markets was adversely affected by the 1997 financial crisis. This is not surprising as in the chaotic financial environment during that time, investors would overreact not only to local news, but also to news originating in the other markets, especially when the news were adverse. Baig and Goldfajn (1999: 167) noted that news of economic and practical distress, particularly bank and corporate fragility, became commonplace in the crisis-stricken countries, and it appeared as though anything that brought one market down put additional pressure on the other markets as well. For instance, Kaminsky and Schmukler (1999) attributed the dramatic surge in the volatility of financial markets partly to the inflammatory statements by government officials. One often cited example in this context is the bitter attack against currency speculators by former Malaysian Prime Minister Mahathir Mohamad during the crisis period, and his tough speech in Hong Kong on 20 September 1997 that called for speculative currency trading to be made illegal and for legitimate currency traders be registered. In fact, each time Mahathir spoke of currency speculators at the height of the crisis, the markets at home reacted negatively, with ringgit depreciation while stocks continued their downward slide. At the end, he had to be reined in by regional government leaders and perhaps his cabinet colleagues (see Jomo, 1998: 715716). In addition to that, the crisis also led to political instability and social unrest in many of the affected countries, most notably culminating in the resignation of president Suharto in Indonesia and prime minister Chavalit Yongchaiyudh in Thailand, and the unexpected sacking and imprisonment of the then Malaysian Deputy Prime Minister and heir apparent Anwar Ibrahim (see Corsetti, Pesenti, & Roubini, 1999; Johnson & Mitton, 2003). Among this group of Asian markets, our statistical analysis reveals that Hong Kong is the worst hit by the crisis in terms of market efficiency. There are a number of domestic events that could unnerve investors in the Hong Kong stock market, in addition to shocks transmitted from other regional financial markets.9 First, on 1 July 1997, Hong Kong's sovereignty was returned to the People's Republic of China, after 156 years of British rule, an event that created uncertainty about its political and economic future. Jao (2001) noted that the handover was another ordeal that Hong Kong went through from 1982 to 1997. In general, the Hong Kong media revealed a sense of uncertainty and confusion about the territory becoming a part of China (see Pan, Lee, Chan, & So, 1999). Second, in the week beginning 20 October 1997, speculators mounted a massive attack on the Hong Kong dollar, and this triggered the response of the Hong Kong Monetary Authority (HKMA) by selling U.S. dollars from its strong reserves. On 23 October, the Hong Kong InterBank Offered Rate (HIBOR) was pushed to an intraday high of 280% to defend its currency peg against speculators, bringing the Hang Seng Index down by 10.4%. Third, from 1428 August 1998, the Hong Kong government used its reserves to engage in massive interventions in the stock markets to protect the Hong Kong dollar and its stock market from speculative attacks. One of the extreme measures undertaken involves taking a long position for all of the 33 constituent stocks of the Hang Seng Index. By 29 August, the Hong Kong government successfully defended the index at the 7800 level, but the price it paid for this success is a staggering investment of HK $118 billion (or US$15 billion) that brought the government as one of the largest shareholders of the 33 composite stocks. Unfortunately, the unavailability of intraday data limits our ability to extend the present analysis in two possible directions: (i) performing the event-matching procedure in Lim, Hinich, and Brooks (2006) to identify those news, both own-country and crossJao (2001) gave a comprehensive account and assessment of Hong Kong's experience during the Asian financial crisis.
9

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Fig. 4. Time series plots for rolling standard deviations over full sample period. Notes: Shaded region corresponds to the crisis period (7/2/1997-12/31/1998).

K.-P. Lim et al. / International Review of Financial Analysis 17 (2008) 571591 Table 5 Correlation coefficient between H statistics and standard deviations Full sample period Hong Kong Indonesia Korea Malaysia Philippines Singapore Taiwan Thailand 0.3122 0.0270 0.1582 0.2333 0.0964 0.0338 0.1961 0.2850 Pre-crisis period 0.0111 0.2857 0.4393 0.3409 0.3502 0.4522 0.4908 0.6226 Crisis period 0.3718 0.3545 0.1506 0.3611 0.0803 0.2968 0.0824 0.2443

587

Post-crisis period 0.0618 0.1179 0.2759 0.5529 0.0044 0.1821 0.0732 0.0085

border, that shook the Asian stock markets during the crisis; (ii) measuring the significance and size of the contributions of these news to the explanation of stock market inefficiency in a regression setting, similar in spirit to those by Baig and Goldfajn (1999), Kaminsky and Schmukler (1999), Jo and Willett (2000), Ellis and Lewis (2001) and Ganapolsky and Schmukler (2001), though their focus is on market returns and volatility during the crisis period. 5.3. Is the nonlinear departure from market efficiency driven by returns volatility? Given that the volatility for Asian stock returns series surged dramatically during the 1997 crisis, the question of whether the reported inefficiency in these Asian stock markets is related to market volatility arises naturally. Theoretically, there is no clear relationship between volatility and market efficiency, but it is always at the core of policy objectives to reduce volatility and enhance market efficiency. To address this issue, the present section examines the correlation between the H statistics (proxy for market efficiency) and standard deviations (proxy for market volatility).10 Since the H statistics are computed for each rolling windows of 50 observations, Fig. 4 plots the estimated daily standard deviations of returns for the corresponding rolling window. The rolling standard deviations give a general idea of the dynamic evolution of volatility over the full period (1/2/199212/31/2005) for all the stock markets under study. For all cases except Taiwan, volatility was at the peak during the crisis period. Table 5 repots the correlation coefficient between the H statistics and standard deviations for the full period and also sub-periods of pre-crisis, crisis, and post-crisis. However, attention is given to the crisis period to determine whether the evidence of market inefficiency is related to the high volatility during that time. As mentioned earlier, the T23 program transforms the H statistic into a percentile (i.e. one minus the p-value) using the cumulative distribution function of the test statistic under the null hypothesis. Hence, a value near 1.0 for the H statistic indicates that the null hypothesis of pure white noise can be rejected with a small p-value, implying market inefficiency. Following this line of reasoning, if market inefficiency is related to high volatility, then we would expect a positive correlation coefficient between the H statistics and standard deviations. However, for the crisis period, the coefficient is negative for Indonesia, Singapore and Taiwan; while Korea, the Philippines and Thailand recorded a sharp decrease from the pre-crisis to the crisis period. Only Hong Kong and Malaysia experienced an increase in the correlation coefficient. As a whole, the results suggest that market inefficiency is not related to high volatility per se. However, these findings are indicative rather than definitive. A more rigorous analysis into this relationship is warranted in future research due to the interesting policy insight.
10

The authors would like to thank Melvin J. Hinich for this suggestion.

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6. Conclusions This paper empirically investigates the effects of the 1997 financial crisis on the efficiency of eight Asian stock markets, an issue which is surprisingly understudied in the literature. Using the rolling bicorrelation test statistic, the statistical findings show that Hong Kong is the most efficient over the 14 years full sample period, followed by Korea and Taiwan, while Malaysia is at the tail end of the ranking list. However, in many cases, the 1997 Asian crisis is responsible for a large portion of inefficiency, notably in Hong Kong, the Philippines, Taiwan and Malaysia. To shed further light on the impact of the 1997 financial turmoil, the rolling H statistics are computed for three sub-periods of pre-crisis, crisis, and post-crisis. On a country-by-country basis, the results demonstrate that the crisis adversely affected the efficiency of most Asian stock markets, with Hong Kong being the hardest hit, followed by the Philippines, Malaysia, Singapore, Thailand and Korea. However, most of these markets recovered in the post-crisis period in terms of improved market efficiency. Based on the working hypothesis of Lim, Hinich, and Brooks (2006) that the evidence of nonlinear serial dependencies indicates equilibrium deviation resulted from external shocks, this suggests that those reported market inefficiency can be associated with news happening during the crisis period. In a related paper, Kaminsky and Schmukler (1999) collected news releases in order to identify the news that rock the Asian stock markets, but these authors acknowledged that the amount of daily news and rumors increases dramatically during the crisis making it hard to control for every piece of new information. Hence, our results of higher inefficiency during the crisis are not surprising as in that chaotic financial environment, investors would overreact not only to local news, but also to news originating in the other markets, especially when the news events were adverse. In terms of policy guidance, if enhancing market efficiency is the objective, the results suggest that credible policy actions to calm the markets and restore investor confidence ought to be the priority (see, for example, Baig & Goldfajn, 1999). However, it would be premature to conclude that restricting capital outflows as adopted by Malaysia is an effective way to stabilize the market, as evidence elsewhere suggests that the trading behavior of foreign investors could not be blamed for the collapse of stock markets at the time of the Asian crisis (see, for example, Bowe & Domuta, 2004; Choe, Kho, & Stulz, 1999; Karolyi, 2002; Lin & Swanson, 2004). On the other hand, government direct intervention in the stock market such as those undertaken by Hong Kong might not be a good option, though the often cited reason for this drastic measure is to reduce investors' anxiety and restore investors' confidence in the market (see Su, Yip, & Wong, 2002: 278). Instead, the present findings suggest that it made the situation even worse. With regards to the effectiveness of price limits system that was in place in some of the Asian stock markets, the high volatility during the crisis period seems to indicate that it was not functioning well. This is not surprising as empirical evidence suggests that the imposition of price limits does not yield the desired effect of reducing stock market volatility (see Kim & Yang, 2004 for a survey of the literature). Though it can be deduced from our results that the price limits are also ineffective in improving market efficiency, a more detailed study in this aspect is needed. Perhaps, an understanding of how the stock market reacts to policy announcements and news might provide some useful clues for crisis management. For instance, Ganapolsky and Schmukler (2001) argued that Argentina was successful in mitigating the contagion effects from the Mexican crisis because the policy makers pursued an active policy by trying to send the right signals to the markets. All these point to the fact that more work needed to be done before policy prescriptions can be given.

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Acknowledgements The authors are grateful to Melvin J. Hinich for his generosity in sharing the T23 FORTRAN program and helpful technical assistance and advice. The comments of an anonymous referee of the journal that have improved the final version of this paper are highly appreciated. The first author thanks Universiti Malaysia Sabah for his PhD scholarship. References
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