Journal - Centre for Banking Studies

Journal of Multidisciplinary Studies

The official journal of the Centre for Banking Studies Central Bank of Sri Lanka

CBS Journal of Multidisciplinary Studies Advisory Editor Mr. K G D D Dheerasinghe Deputy Governor Central Bank of Sri Lanka Managing Editor Mr. U P Alawattage Director Centre for Banking Studies Central Bank of Sri Lanka Editorial Board

Dr. D S Wijesinghe Former Deputy Governor Central Bank of Sri Lanka Board Member HDFC Bank, Sri Lanka Board Member FITCH Rating (Lanka) Ltd.

Prof. Danture Wickramasinghe Hull University Business School The University of Hull, UK

Prof. Uditha Liyanage

Dr. P N Weerasinghe Assistant Governor Central Bank of Sri Lanka and Alternate Executive Director for Bangladesh, Bhutan, India and Sri Lanka – International Monetary Fund

Prof. Lalith P Samarakoon University of St. Thomas Minnesota, USA

Dr. D B P H Dissa Bandara

Director Postgraduate Institute of Management University of Sri Jayewardenepura Sri Lanka

University of Sri Jayewardenepura Sri Lanka Director, Financial Services Academy Securities & Exchange Commission of Sri Lanka

Prof. Premachandra Athukorale

Mr. Deepal Sooriyaarachchi

Professor of Economics College of Asia and the Pacific Australian National University Australia

Mr. B D W A Silva Assistant Governor Central Bank of Sri Lanka

Prof. Peter Sinclair Professor of Economics University of Birmingham, UK

Management Consultant Director, AVIVA- NDB Insurance Co. PLC and Sampath Bank PLC Sri Lanka

Mr. K D Ranasinghe Director Economic Research and Chief Economist Central Bank of Sri Lanka

Mr. R M B Senanayake General Manager Research & Development, SKM Lanka Holdings and Monetary Policy Committee Member Central Bank of Sri Lanka

Prof. Thankom Arun Gopinath Director, Institute of Global Finance and Development Professor of Development Finance and Public Policy, Lancashire Business School The University of Central Lancashire Honorary Senior Fellow, School of Environment and Development Brooks World Poverty institute The University of Manchester and Research Fellow, IZA

The CBS Journal of Multidisciplinary Studies encourages multidisciplinary research which has a policy relevance. This is a peer reviewed journal published annually. Views expressed in the CBS Journal of Multidisciplinary Studies are not necessarily those of the Centre for Banking Studies (CBS) of the Central Bank of Sri Lanka. Material may be reprinted or abstracted if the journal and authors are credited. Free electronic copies are available from the CBS website: http//www.cbscbsl.lk. Printed copies are available at Centre for Banking Studies, No. 58, Sri Jayewardenepura Mawatha, Rajagiriya, Sri Lanka. Contact numbers: (9411) 2477811, (9411) 2477840, (9411) 2477821 & (9411) 2477810. VOL. 1 NO. 1 December 2010

ISSN: 2012 – 791X

CBS Journal of Multidisciplinary Studies

CONTENTS

PAGE Editorial Note

1.

International Stock Market Price Linkages: Evidence from Sri Lanka and its Main Trading Partners

i - iv 1 - 16

S. Sivarajasingham

2.

Factors Affecting the Adoption of Agricultural Forward Sales Contracts in Sri Lanka

17 - 24

K S Karunagoda, K P N S Karunagoda, H P Gunawardhane, S P R P Senanayake and Y M Wickramasinghe

3.

An Empirical Examination of Informational Content of the Dividend Announcements in Sri Lankan Share Market

25 - 40

D B P H Dissa Bandara and K D I Perera

4.

Interest Rate Behaviour: The Sri Lankan Case

41 – 53

W M Hemachandra

5.

Multi-Elements of Exchange Rate Exposure: Evidence from Japanese Sectoral Returns

54 - 72

Prabhath Jayasinghe and Albert K Tsui

6.

HR Managers of South Asian Banks: A Study of Strategic Orientation

73 – 88

Ajantha S Dharmasiri

7.

Book Review: The Cost of Capitalism: Understanding Market Mayhem and Stabilising Our Economic Future P W D N R Rodrigo

89 - 92


Editorial Note The Centre for Banking Studies (CBS) of the Central Bank of Sri Lanka for more than two decades now, has been in the forefront of disseminating global wisdom and modern knowledge to bankers in particular and the public in general, earning an unparalleled reputation for its knowledge enhancement devices. Its modus operandi in this venture had principally been the use of face to face training and learning techniques: seminars, conferences, workshops and public debates. The impact which it has made on human capital development and organizational leadership has widely been acknowledged. Now, we have come to the stage that we need to take our programs to the next logical step by evolving ourselves into a centre of creation and dissemination of knowledge through multidisciplinary research. This is considered to be crucial in assessing and understanding how far and well we can adapt and adopt the euro-centric global knowledge to suit our idiosyncratic cultural and economic conditions in order to achieve our development needs and goals.

CBS Journal of Multidisciplinary Studies is the result of this vision. It is based on the understanding that economic, sociological and management research has been too compartmentalized to the extent that we no longer see the holistic picture within which economic, sociological and organizational dynamics evolve and are to be managed. The implication of this compartmentalization is sometimes rather embarrassing that our collective understanding of the organizational and economic realities is very akin to the fable of “elephant and the blind men”. However, this is not something for which we should blame ourselves. It has been our nature over the last two centuries or so; it has been the historical result of the way that knowledge has been institutionalized in the West and then superimposed upon the peripheral East and South. This is very evident if we take a brief look at how ‘disciplines’ have historically been branched out to various compartments within which ‘modern’

1

specializations began to take place.

Historically, all esoteric knowledge about human, social and physical behaviour was viewed as indivisible unit called as ‘philosophy’. Over the time, this single skein of knowledge divided into two basic strands called natural and moral philosophy. This had been the case in pre-modern institutions of learning, especially medieval Western universities.

Subsequently, natural philosophy was

transformed and re-labeled into natural science with the advent and authority of physical sciences. In

1

I use the term ‘modern’ here (and also the term modernity later on) with its sociological connotations rather than its common usage to mean current knowledge. In that sociological sense, modern (in contrast to premodern) refers to the historical phase after the Enlightenment and French Revolution, a period within which, in the West, people are said to be emancipated from religious dogmas and the state is said to be separated from the divine powers of the Church. More importantly, this is the period within which secularity was institutionalised as an overriding feature of human knowledge, and secular institutions of knowledge and sciences (such as universities and professional bodies) are established as the principal mode of knowledge creation and dissemination.

i


pursuit of this trend and prestige of science, moral philosophy was also re-labeled as moral science which deals with the knowledge of human relationships (Easton and Schelling, 1991).

However, the detailed division and compartmentalization of knowledge into various disciplines (such as economics, sociology, anthropology, management and then into further subdivisions such as marketing, human resource management, operations and production, accounting and finance and so 2

on) was the result of institutional evolution of capitalism and modernity in the West. For Foucault (1994), this is the genealogy of power, especially the penetration of 'pastoral power' into the secular institutions. By the term 'pastoral power' what Foucault meant was the special form of power that traditionally Christian pastors were exercising by virtue of their religious qualities. This power was exercised through institutionalized rituals of confession and designated a very special form of power which, through its penetration into secular institutions, had a far reaching effect on the division and compartmentalization of knowledge.

The obvious question that will arise in this respect would be, how this pastoral power, which is rather an ecclesiastical notion of power, got to do with economics and management, especially when the ecclesiastical exercise of that power is no more a vital part of modern societies.

According to

Foucault (1994), it is this pastoral power that has spread and multiplied outside the ecclesiastical institutions but within various forms of secular institutions such as schools, universities, professional bodies, hospitals, factories, government departments and, after all, economic enterprises such as corporations (note that all these institutions are products of the modernity and capitalism, and was not in existence before that). Within such secular organizations, in contrast to the Church, the pastoral power now assumes a change in its objective: not the salvation in the next world but, rather within this world. As such the notion of 'salvation' takes on different forms: development, poverty reduction, employment, health and wellbeing, safety and security, education, customer satisfaction, employee happiness and even profit maximization.

As the objective of 'pastoral power' is secularized the officials holding that pastoral power has been multiplied. Instead of pastors in the Church, now we have doctors, lawyers, accountants, economists, engineers, and managers whose focus is now on the development, dissemination and application of knowledge for betterment of human lives within various organizations.

For a Christian pastor,

knowing the inner soul of the confessant is the key to direct him/her to the salvation in the next world. For these new pastors, knowing the sciences and laws of human body, human mind, society, economy, markets, politics, culture and so on is the key to the salvation within this secular institutional set up. As such, "this implies that power of a pastoral type, which over centuries has been linked to a defined religious institution, suddenly spread out into the whole social network and It found support in a multitude of institutions" (Foucault, 1994, p.335). Thus we have replaced the Church with various

2

See note 1 above.

ii


economic and social institutions and also economic enterprises as the institutional framework within which these new modes of pastoral power are exercised.

And more importantly, development,

dissemination and deployment of human knowledge have been compartmentalized into various 'faculties of knowledge' within which we produce esoteric knowledge, owners of which can qualify themselves as 'modern pastors' - elites who are empowered by the ownership of that knowledge to direct and lead others for collective and individual 'salvation' but only within their respective field of specialization.

So was the story of division of knowledge. These sub disciplines are considered to be invaluable and undoubtedly have contributed a lot by way of developing precise knowledge, concepts, theories and skills for the purpose of systematic inquiry to improve our understanding the world around us. However, it is now becoming increasingly apparent that the intensity of specialization and fragmentation of knowledge is so rapid and scholars (i.e. modern pastors) have difficulty in maintaining of such divided knowledge within their own small niches. Rather there is a substantial overlapping of knowledge between disciplines and when it comes to application of knowledge it demands a holistic approach for effective results. Though still it is debatable whether heavy specialization is conducive towards creation of knowledge and their application over generalization, the pendulum has started swinging from the notion of heavy specialization towards convergence of multiple disciplines, particularly in the area of policy studies. Therefore, multi-disciplinary research for that matter has gained core attention in the recent past in the area of knowledge creation and research in particular. In other words, the world is now seeking a proper balance and coordination between these multitude divisions of human knowledge.

CBS Journal of Multidisciplinary Studies is such an attempt. Its primary objective is to promote multidisciplinary research on economy, society and organizations, particularly of LDCs so that we will have a broader understanding of social, economic and organizational conditions within which various policy proposals have to be implemented. However, we also understand that we have been the product of specializations and compartmentalization mentioned above, and hence it could be too ambitious to seek broader multidisciplinary convergence within individual papers. We know that many of us still working within our own knowledge compartments find our comfort within them. Hence, our strategy of multi-disciplining the journal is to collect a set of papers addressing multiple issues, adopting multiple theoretical and methodological perspectives (the way we see things) and approaches (the way we do things). As such the scope of the journal is very broad and would accommodate theoretical and empirical studies with no particular preference to any selected methodological stance. However, CBS Journal of Multi-disciplinary Studies encourages policy oriented action research to support policy discussions in macro-economic, wider social and micro organizational issues. This is encouraged because, it is recognised, that such policy issues will provide the necessary basis upon which we can bring hitherto compartmentalized knowledge together.

iii


Although the journal encourages local issues particularly, and LDC issues generally its operational apparatuses are international by nature. It has established an international network of academics and professionals for editorial and review activities. I am proud to mention that this network of reviewers covers such a broader spectrum of academic disciplines and methodological stances that enables the journal to effectively project itself as truly multidisciplinary.

Udeani P. Alawattage Managing Editor

References Easton, D. and Schelling, Corinne S. (1991), "Divided Knowledge: Across Disciplines, Across Cultures, London: Sage Publications. Foucault, M. (1994), Power: essential works of Foucault 1954-1984, volume 3, (Translated by Robert Hurley and others, Edited by James D Faubion), London: Penguin Books.

iv

International Stock Market Price Linkages: Evidence from Sri Lanka and its Main Trading Partners S. Sivarajasingham1

Abstract This paper investigates long term linkages among stock markets in six developed countries and five emerging-market economies in South-East Asia using daily closing stock markets price indices for the period of November 2, 1987 to December 1, 2006. Multivariate cointegration tests and other related statistical techniques were applied while paying attention to a possible structural break resulting from the 1997-98 Asian financial crisis. The results suggest that the Asian stock markets have become more interdependent and internationally integrated after the Asian financial crisis. The Sri Lankan stock market had statistically significant long run relationships with the stock markets of India, US, and UK in the pre Asian crisis period and with Hong Kong, India, South Korea and Singapore in the post-crisis period. The main policy inference is, therefore, that the authorities of Sri Lanka and other Asian countries need to coordinate macroeconomic policies with each other to avoid any spillover effects following any turmoil in one country or more countries of the region. Key words: Stock market linkages, Multivariate Cointegration, Vector Error correction Model,

1. Senior Lecturer, Department of Economics and Statistics, University of Peradeniya. Mr. Sivarajasingham acknowledge the contribution of Prof Jan G.De.Goojer, Prof H.P. Boswijk and Prof J.F. Kiviet, University of Amsterdam, Prof R.O Thattil, University of Peradeniya for their comments, encouragement and support.

1


1.

Introduction:

Globalization and financial market liberalization have brought international stock markets to move together over the years. The Linkages among stock markets are important not only for international capital market integration but also for the integration of the goods and services markets to be effective. The empirical analysis of linkages among international stock markets is important in terms of theory, practice and policy; theoretically as an input to international portfolio diversification models, practically for international investors to know international diversification benefits, and from policy point of view for informing financial market regulators about the extent of market linkages. The issue of whether the stock markets are cointegrated carries important practical implications for portfolio diversifications. (Grubel, 1968). If stock prices are cointegrated, it implies that there is a common force, such as arbitrage activity, which brings stock markets together in the long run, and hence the gains from international asset diversification is limited. By contrast, if markets are not cointegrated, investors can obtain long run gains through international portfolio diversification (Masih and Masih, 1997). The main objective of this study is to investigate the linkages among the stock market of Sri Lanka and that of its main trading partners in the long run. It is also attempted to see whether Asian financial crisis has any influence on the degree of linkages among the selected stock markets. Currently, there exists no in-depth analysis of the linkages and interdependence structure of Sri Lankan stock market with that of its main trading partners. This paper intends to fill this gap. It Investigates long term linkages of the Sri Lankan stock market with stock markets in six developed countries and five emerging-market economies in South-East Asia using daily closing stock markets price indices for the period of November 2, 1987 to December 1, 2006. Multivariate cointegration tests and other related statistical techniques are applied while paying attention to a possible structural break resulting from the 1997-98 Asian financial crisis. If a common stochastic trend exists among stock markets, stock markets are cointegrated. If the stock markets are segmented, investors can gain potential benefits by portfolio diversification. The paper is organized in five sections. Section 2 surveys the related empirical literature in order to provide the context for the ensuing empirical analysis. The econometric methodology is discussed in Section 3. Data sources and variable construction are discussed in Section 4. Results are presented and discussed in Section 5. The paper ends in Section 6 with a summary of the key findings and policy inferences.

2.

Literature Review

The available empirical evidence on international stock market linkages has shown mixed and conflicting results. Some studies conclude that international stock markets are interdependent. Example: Eun and Shim (1989), Von Furstenberg and Joen (1989), Bertera and Mayer (1990), Kasa (1992), Cheung and Mak (1992), Arshanapalli and Doukas (1993), and Masih and Masih (1997a, 1997b, 1999). While, others have found evidence of market segmentation. Dwyer and Hafer (1988), Chowdhury (1994), Kwan et al (1995), Elyasiani, Perera and Puri (1998), report that the stock markets are not interdependent. The findings of these studies are not strictly comparable as they were conducted on different stock market indices over various sample periods, and using different methodologies. There is a large empirical literature on the interdependence among stock markets in developed countries. In recent years, there has also been a sizeable literature on the interdependence of emerging stock markets and developed stock markets. However, so far only one study has dealt with this issue relating to the Sri Lankan stock market (Elyasiani, Perera, and Puri 1998). This study investigated the interdependence between Sri Lankan stock market and its main trading partners- Hong Kong, India, Japan, South Korea, Singapore, Taiwan and US by applying the VAR model to daily data for the period of 1st January 1989 to 10th June 1994. This study differs from Elyasiani, Perera, and Puri (1998) in several respects. It investigates the linkages separately for the periods before and after the 1997-98 Asian financial crisis covering the period from November 2, 1987 to December 1,

2


2006. The study includes six developed markets and five emerging Asian markets. It employs Engle-Granger bivariate cointegration test, and Johansen ‘s multivariate vector error correction methods which are preferable to VAR model in testing long-run economic relationships.

3.

Analytical frame work

Cointegration is referred to as an economic concept of a long run equilibrium relationship. Let Yt be a nx1 vector of variables, multivariate process with components that are integrated of order one. The components of degenerate linear combination

Yt are cointegrated if and only if there exists a non with   0 , such that  Yt is stationary. i.e  Yt

 Yt ~ I (0) . This stationary linear combination is called the cointegrating equation. When  Yt  0 , variables are in long-run equilibrium. The deviation from long-run equilibrium is called equilibrium error. It is noted as z t   Yt . If the error process is stationary, then the coefficients in  can be interpreted as reflective of long-run (steady state) relationship (Engle and Granger, 1987). Some normalization assumption is required to uniquely identify  normalization

  (1, -  2 , -  3 ,........   n )

is

 Yt  (Y1t   2Y2t  ........ nYt ) ~ I (0) . =0 ut Y1t   2Y2t  ........   nYnt

run

equilibrium,

and

The cointegrating error

the

long

run

in

 Yt .

A typical

so

that

u t ~ I (0) . In the long

equilibrium

relationship

is

A variety of econometric methodologies are employed in this study in order to achieve robustness of the results. Multivariate cointegration method is employed to examine the long run relationships among the stock markets. The statistical notion of cointegration is well suited to study the co-movements of a set of variables in the long run. First, preliminary diagnostic tests are done by using summary statistics, contemporaneous correlations, autocorrelations and unit root analysis. Then, multivariate cointegration analysis is done to examine the dynamic linkages among those stock markets. This study uses the system based test of the Johansen procedure.

3.1

Statistical tests used in the study

a) Unit root test was performed to check whether the time series are stationary or not. The standard unit root tests used were ; augmented Dickey- Fuller test(Dickey and Fuller, 1979, 1981) and the Phillips-Perron test (Phillips and Perron 1988). b). Multivariate cointegration test (Johansen’s Procedure) proposed by Johansen (1988, 1991) and Johansen and Jusellius (1990) was used to investigate the dynamic comovement among stock prices and the adjustment process towards long term equilibrium. Johansen analysis is expressed in vector error correction model VECM. The Standard linear vector error correction representation of the VAR model for the n variables has the form as

Yt  Yt 1  Where

Yt 1

p 1

 i Yt i i 1

 t

is the error correction term. This measures the deviation from long run

equilibrium and induces a correction by its effect on

Yt towards

equilibrium.

long run response matrix. It measures the cumulative long run effects.

3



is called


Johansen (1989, 1990) has shown that the coefficient matrix contains sufficient information to determine the cointegrating relationships between the variables. The rank of matrix  is the number of cointegrating relationships between the variables in Yt. Let the rank of  be r. The rank of a matrix is equal to the number of its characteristics roots or eigenvalues ( (i ) The number r can be more than one and can go up to n-1. On the basis of rank of distinct cases can be identified.

 , three

Case I: When the rank of  =0, r=0, there are no cointegrating relationships. The Vector auto-regression (VAR) polynomial (z ) contains n unit roots, n stochastic trends. In which case, all of the variables are non-stationary. There are no stationary long run relations among the elements of Yt. In this case the variables do not have common stochastic trend and hence do not move together over time. Therefore, it is not possible to obtain stationary cointegration relations between the levels of the variables. Case II: when  has full rank, r=n, all of the variables in levels are stationary and standard inference applies. (z ) has its roots outside the unit circle. There is no any stochastic trends. All variables are I(0) , the issue of cointegration is not relevant. Case III: When  is less than full rank but not equal to zero. i.e 0 < r < n , intermediate rank. There are r linear combinations of the non-stationary variables that are stationary. i.e. there are r cointegrating relationships. the polynomial (z ) has n-r units roots/ common

Yt 1 is I(0). In this case  can be written as

stochastic trends. This indicates that

    . 3.2

Full system of estimation

The system,

Yt  Yt 1 

p 1

 i Yt i i 1

system Maximum Likelihood assuming that collected in a matrix

  t , can be estimated by full

 t ~ N (0, ) and iid. Let the parameter i

  [1 ,.......n1 ] and the variables Yt i

Z t  [Yt1 ,.........Ytn1 ]

such that

be

in

Yt  Yt 1  Z t   t .

The likelihood

function is then

 1  L( ,  , , )  (2 ) (Tn / 2) |  | T / 2 exp   (Yt  Z t  Yt 1 )  ------------ 2 t  (1) With

    .

In Johansen’s procedure, Gaussian maximum likelihood is used to estimate all parameters of the ECM. This procedure is an asymptotically nuisance parameter free. This approach allows us to obtain estimates of the coefficients of the matrices  and  through a procedure known as reduced rank regression. The estimated parameters on the ECM can be partitioned to provide information on the long run relationship and short run dynamics. The long run relationship can be identified through testing hypothesis on  . The short run dynamics can be identified through testing hypothesis in

4




3.3

Optimal lag:

Boswijk and Franses (1992) emphasized the sensitivity of the cointegration test to the choice of the lag length. They found that underestimating the lag length can lead to the rejection of the null hypothesis of no cointegration too often, where as over parameterization of the dynamic structure leads to loss of power. Therefore, the choice of optimal lags for the VAR system is selected based on the most widely used the Akaike Information Criterion (AIC). The information criteria are computed using the full system loglikelihood. Loglikelihood value is computed assuming a multivariate normal distribution. The Akaike Information Criterion is given by AIC  2(l / T )  2(k / T ) where l = the value of the log likelihood function, k=total number of estimated parameters in the VAR. T= number of observations. By minimizing AIC , the appropriate lag lengths were selected.

3.4

Determining the Number of Cointegration Relations (rank of  )

According to Johansen (1988) and Johansen and Jusellus (1990), there are two different likelihood ratio (LR) statistics to test for cointegrating vectors, namely (i) the trace test statistic, (ii) the  max test statistic. Test statistics are based on the characteristic roots ( eigenvalues,

3.5

ˆi ) obtained from

the estimated

Speed of adjustment



 matrix.

and Weak Exogeneity Test:

The factor loading matrix,  , contains information the speed of adjustment towards the long run equilibrium . The error correction coefficients can be used in exogeneity inference. Johansen (1992) developed a test based on the notion that variables that do not respond to ‘disequilibrium’ in the system of which they are a part may be considered weakly exogenous to that system. An insignificant loading coefficient thus indicates the corresponding weakly exogenous stock price. Each of the variables for weak exogeneity can be tested on the hypothesis of weak exogeneity is where

i=1,2,3,….11

denotes

H 0 :  i1   i 2  0

as

2

H 0 :  i1  0 the

i

th

country



matrix. The null

in the case of one cointegration vector considered

in

this

study

and

in the case of two cointegration vectors. The tests are distributed

with 1 degree of freedom. Weak exogeneity implies that there is no feedback from

deviations from long run equilibria for certain variables.

4.

The Data

The data used in this study consists of daily closing stock price indices over the period from November 2, 1987 to December 1, 2006 for eleven countries ( Germany, Hong-Kong, Japan, Singapore, UK, USA, India, Malaysia, South Korea, Taiwan). These data were collected from the Datastream. The sample consists of 4980 observations per country. All stock price indices are expressed in local currencies. The stock price index for each of the 11 countries are as follows: all share price index for Sri Lanka; FAZ General price index for Germany; the Hang Seng Price index for Hong Kong; the BSE National price index for India; the Nikkei 500 for Japan; The Kuala Lumpur Composite price index for Malaysia; the Singapore Straits Times Index for Singapore, the Korea Se Composite price index for South Korea; the DS-market EX TMT Price index for Taiwan; the FTSE 100 price index for UK; and the DJCMP65 for U.S. The vector of stock prices indices is denoted as follows

Yt  [GER, HNG, JAP , SNG,UK ,US, IND, MAL, SK , SL, TAW ]

5


The sample period is divided into the Pre and Post Asian financial crisis periods on the basis of 1997-1998 Asian financial crisis to address the impact of this crisis on the interdependence of the stock markets. The two sample periods are; 1. Pre Asian crisis 1997 (P1): November 2, 1987 to June 30, 1997 ( 2521 observations) 2. Post Asian crisis1997 (P2): June 1, 1998 to December 1, 2006 (2220 observations) The Asian financial crisis started with the devaluation of Thailand’s Baht which took place on July 2, 1997, a 15 to 20 percent devaluation. Following this devaluation, a series of currencies as the Phillippine Peso, the Malaysian Ringgit, The Indonesian Ruppiah, and the Singaporean dollar started to devalue. These series of devaluations marked the beginning of the Asian financial crisis. The crisis period covered July 2, 1997 to May 30 1998 (Garay 2003). The sample countries were selected on the basis of trade share (export and imports share) of Sri Lanka. The value of share indicates as an average, calculated for 10 years, 1995-2005, exports and imports data. Table 1 reports the share percentage of imports from a country out of total imports of Sri Lanka and the share percentage of exports for a country out of total exports of Sri Lanka. Table 1: Sri Lanka’s main trading partners trade share Country Exports share(%) Imports share(%) Germany (GER) 4.8 2.5 Hong-Kong (HNG) 1.3 7.4 Japan (JAP) 3.9 7.4 Singapore (SNG) 1.3 6.5 UK (UK) 11.8 4.2 USA (US) 36.3 3.4 India(IND) 2.8 12.1 Malaysia (MAL) 0.3 3.5 South Korea (SK) 0.6 5.5 Taiwan (TAW) 0.3 5.0 Source: Various issues of Annual reports, Central Bank , Sri Lanka.

5.

Empirical Results:

This section focuses on the analysis of the empirical results from the performed econometric and statistical tests. All estimations have been done in EViews. Excel software was also used for ordinary calculations.

5.1

Preliminary Diagnostic Check:

In order to get a general view of the stock price series included in this study, the basic statistical properties of these stock market price indices were investigated. All stock price indices are transformed into natural logs. All indices are converted to same base period. Their time series and statistical properties are investigated through graphical representations, Summary statistics, contemporaneous correlations, auto correlation function and unit root tests. Summary statistics of daily price changes are provided in table A1 and A2 of the Appendix. These statistics describe stylized facts of the stock price series. The kurtosis of all stock price series were much larger than the normal distribution value(3). Of the 11 countries, 8 had stock returns, negative skewness in the post crisis period while 6 countries had stock returns which were negative in the pre crisis period. The negative skewness implies that large negative returns tend to occur more often than large positive ones. Although Sri Lanka has positive skewness in both periods, the positive magnitude decrease in period P2. These results are consistent with the literature that return series in various stock markets have fat tails and negative skewness.

6


Contemporaneous correlation matrix of stock price indices of the selected eleven countries is shown in Table A3 of the Appendix. This information gives a general understanding of the overall relationships between the stock markets. The values below diagonal of the matrix indicate the correlation coefficients for the Pre Asian financial crisis period. The values above the diagonal of the matrix indicate the correlation coefficients for the Post Asian financial crisis period. It is interesting to note that all coefficients are statistically significantly different from zero at the 1% level for both sample periods. The magnitudes of these coefficients are very small. The low correlation coefficients indicate that international diversifications among these markets are effective. The negative correlation coefficient in the pre crisis period turned to positive in the post crisis period. This implies that stock markets are linked positively after the Asian financial crisis. Very low cross correlations at lag 0 were obtained for the pairs SL-JAP, SL-TAW, SL-UK, and SL-US. However, correlation analysis cannot fully capture the long term dynamic linkages between the stock markets in a reliable way. As stock price indices are nonstationary and having serial correlation, correlation estimates are subject to statistical limitation. Therefore, contemporaneous correlation analysis does not clearly imply a great deal about international stock price linkages. Correlation techniques provide only a partial insight into the existence of the relationships between stock market prices. It is reported here for the purpose of preliminary diagnostic checking. Sample autocorrelation of all the price series die off slowly (a clear linear decline) with very large values of first order auto correlations. All the stock price series were nonstationary. All sample PACF of all the series cuts off after lag 1. Sample PACFs for all the series show that the first PACF to be relatively significant and all the remaining ones to be not significantly different from zero. It indicates that all the price series in both sample periods are ~ I(1) processes. The P values of ADF and PP tests indicate that all series in level form are nonstationary, I(1), in both sample periods. The ADF and PP test statistics calculated for each series in level indicate that there is no sufficient evidence to reject the unit root hypothesis at 1% level. The ADF and PP tests for the null hypothesis of a unit root test suggest that each series are stationary at their first differences (p 10 yrs 38% 42%