Asian Equity Markets
Growth, Opportunities, and Challenges

Asian equity markets have grown significantly in size since the early 1990s, driven by strong international investor inflows, growing regional financial integration, capital account liberalization, and structural improvements to markets. The development of equity markets provides a more diversified set of channels for financial intermediation to support growth, thus bolstering medium-term financial stability. At the same time, as highlighted by the May-June 2006 market corrections, the increasing role of stock markets potentially changes the nature of macroeconomic and financial stability risks, as well as the policy requirements for dealing with these risks.

Abstract

Asian equity markets have grown significantly in size since the early 1990s, driven by strong international investor inflows, growing regional financial integration, capital account liberalization, and structural improvements to markets. The development of equity markets provides a more diversified set of channels for financial intermediation to support growth, thus bolstering medium-term financial stability. At the same time, as highlighted by the May-June 2006 market corrections, the increasing role of stock markets potentially changes the nature of macroeconomic and financial stability risks, as well as the policy requirements for dealing with these risks.

I. The Emergence of Asian Stock Markets2

A. Overview

Asian equity markets are sizable and fast growing. Since 1990, Asia’s capitalization has more than doubled in U.S. dollar terms to $13.7 trillion, 30 percent of world capitalization. Excluding Japan and Australia, it has risen almost tenfold. The financial hubs of Hong Kong SAR, Singapore, and Japan dominate the region, accounting for two-thirds of Asian equity assets. Markets in some other countries, such as Malaysia, and Taiwan Province of China, are also sizable. But, for the most part, market capitalization remains well below industrial country levels.

Figure 1.
Figure 1.

Comparison of Equity Market Size in Asia and Other Emerging Markets, 2005

(In percent of GDP)

Citation: IMF Working Papers 2006, 266; 10.5089/9781451865264.001.A001

Sources: CEIC Data Company Ltd; S&P, Emerging Market Database; and IMF, APDCORE database; IMF, World Economic Outlook (WEO); and IMF staff estimates.
Figure 2.
Figure 2.

Growth in Depth of Equity Market, 1990–2005 1/

(In percent)

Citation: IMF Working Papers 2006, 266; 10.5089/9781451865264.001.A001

Sources: CEIC Data Company Ltd; S&P, Emerging Market Database; and IMF, APDCORE database; IMF, World Economic Outlook; and, IMF staff estimates.1/ Change in market capitalization to GDP.2/ Data on Indonesia starts in 1993; data on China, South Africa, and G-7 start on 1992; data for Russia starts in 1996.

The growth in Asian markets has been accompanied by improved liquidity and breadth. Since 1990 market liquidity (share turnover) has more than doubled in relation to GDP, while turnover velocity (share turnover/market capitalization) has risen almost fourfold. Market breadth (the percentage of market capitalization and turnover accounted for by the ten largest companies—a higher figure implies greater concentration) is now greater in Asia than in other emerging markets, although less than in industrial countries.3

There is, however, considerable diversity within this broad picture. Equity markets in China and Indonesia remain illiquid and small relative to the size of their domestic economies, with growth trailing the rest of the region. Market liquidity is also low. In China, the nascent state of the equity market reflects the dominance of poorly performing state-owned companies, which account for about half of total market capitalization (McKinsey Global Institute, 2006a). The majority of China’s successful companies choose to list overseas, primarily in Hong Kong SAR. In Indonesia, the development of the stock market has been hindered by weaknesses in transparency, information disclosure policies, and corporate governance. Markets in the Philippines and Hong Kong SAR are dominated by relatively few firms. Markets such as Bhutan, which are outside the emerging-markets universe focused on by international investors, face unique challenges.

While Asian finance remains bank-dominated, stock markets are an important source of corporate finance (Table 3). In 2005, companies in emerging Asia tapped equity markets for some $814 billion in new capital through initial and secondary public offerings (Table 1). However, issuance activity is highly concentrated within the region: Hong Kong SAR accounted for almost half of total Asian issuance, with the next largest market (India) raising just over one-fifth of the total. Overall, equities provide around 10 percent of corporate financing in emerging Asia, but this compares favorably with 3.7 percent in emerging markets outside Asia. Equities are also a large share of financial assets in the region, accounting for about half of assets (deposits, stocks, and bonds) (Figures 3 and 4 and Table 2). Nevertheless, as a share of assets, equities generally have yet to recover to pre-Asian-crisis levels.

Table 1.

Indicators of Stock Market Activity, 2005

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Sources: Federation of World Exchanges; IMF, WEO database; and IMF staff estimates.

Average daily trading volume (total value of share trading divided by number of trading days).

Defined as the ratio of stock turnover to stock market capitalization.

Shows the part represented by the 10 most capitalized domestic companies in domestic market capitalization.

Shows the part represented by the 10 most traded companies in share trading value.

U.S. secondary public offering only includes New York Stock Exchange (NYSE).

Table 2.

The Evolving Role of Equity in the Financial Sector

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Sources: World Federation of Exchanges; IMF, IFS and WEO databases; World Bank, WDI database; Bank for International Settlements; and IMF staff estimates.

Only includes domestic issuers.

Table 3.

Issuance by the Private Sector, 1990–2004

(In billions of U.S. dollars)

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Sources: Dealogic; IMF, IFS database; S&P EMDB; and Hong Kong Monetary Authority.

Emerging markets: China, India, Malaysia, Korea, Thailand, Argentina, Brazil, Chile, Colombia, Mexico, Czech Republic, Hungary, Poland, Russia, and Turkey.

Figure 3.
Figure 3.

Financial Assets, 2000

(In percent of GDP)

Citation: IMF Working Papers 2006, 266; 10.5089/9781451865264.001.A001

Sources: Federation of World Exchanges; IMF, International Financial Statistics database; IMF, WEO database; World Bank, World Development Indicators database; and IMF staff estimates.
Figure 4.
Figure 4.

Financial Assets, 2005

(In percent of GDP)

Citation: IMF Working Papers 2006, 266; 10.5089/9781451865264.001.A001

Sources: Federation of World Exchanges; IMF, IFS database; IMF, WEO database; World Bank, WDI databse; and IMF staff estimates.
Figure 5.
Figure 5.

Global Exchange-Based Trading of Equity Derivatives in 2005

(By notional amount)

Citation: IMF Working Papers 2006, 266; 10.5089/9781451865264.001.A001

Source: Respective countries’ exchanges.1/ Emerging Asia includes India, Korea, Malaysia, Hong Kong SAR, and Taiwan POC.2/ Mature Market Asia includes Japan, Australia, New Zealand, and Singapore.

Equity derivatives have flourished in a few markets in Asia (Appendix I). On Asia’s exchanges, equity derivatives have witnessed the most rapid growth of all traded derivative products. Equity derivative trading in emerging Asia has mushroomed from $16.5 trillion in 2002 to $40.3 trillion in 2005 (or 35.3 percent of global trading). By the end of August 2006, trading claims even 38.6 percent and 43.9 percent of worldwide turnover by notional value and number of trades respectively.4

This mainly represents very rapid growth in Korea’s market, which thanks to contract specifications and a trading environment that are friendly to retail investors, hosts the world’s most active derivatives market. In 2005, its daily turnover totaled some $151 billion, or almost 34 percent of worldwide trading (83 percent of trading in all of Asia). By comparison, the average daily turnover in all of the Western Hemisphere, including the U.S. and Brazilian markets, was about $168 billion in 2005. Since 2000, growth in overall derivative trading only in Korea, Hong Kong SAR, and Taiwan POC has outstripped growth of both domestic market capitalization and cash trading in equity markets. India’s equity derivatives market is also significant in size and dominates the global trading in equity futures. Equity derivatives markets are much less well-developed in other Asian countries, even ones where cash market activity is strong. Variations in derivatives markets development relate mainly to differences in the operational and legal infrastructure (Fratzscher, 2006).

B. Factors Driving the Development of Asian Equity Markets

International Investor Diversification

Equity flows into emerging Asia have soared (Figures 6 and 7). Inflows have been especially strong in recent years, notwithstanding occasional outflows (for most countries, only a portion of the inflows that occurred in the early part of 2006 were reversed during the May–June selloff.) By end-2004, international investors had invested some $638 billion in emerging Asia equity markets—a twelvefold increase over 1990s levels.

Figure 6.
Figure 6.

Portfolio Assets Held by Nonresidents in Emerging Markets

(In percent of GDP)

Citation: IMF Working Papers 2006, 266; 10.5089/9781451865264.001.A001

Source: Lane and Milesi-Ferretti (2006)
Figure 7.
Figure 7.

Nonresident Equity Investment, 2004

(In percent of GDP)

Citation: IMF Working Papers 2006, 266; 10.5089/9781451865264.001.A001

Source: Lane and Milesi-Ferretti (2006)

Accordingly, emerging Asian markets now capture three-quarters of global equity investments in emerging markets, up from about half in 1992. One underlying factor is the explosion of flows from dedicated emerging market equity funds, whose assets have grown at rates in excess of 54 percent per year since 2000 (Figure 8). With assets of some $125 billion, such funds are important investors in the region. But this figure understates the presence of global investors, since Asian markets likely capture a significant share of the much larger assets managed by global investment funds.

Figure 8.
Figure 8.

Dedicated Asia and Global Equity Funds

(In billions of U.S. dollars)

Citation: IMF Working Papers 2006, 266; 10.5089/9781451865264.001.A001

Source: EmergingPortfolio.com.

International investors now play a key role in many Asian markets. Such investors are concentrated in markets such as Korea, Hong Kong SAR, Taiwan Province of China, India, and Singapore, with portfolio allocations to ASEAN countries relatively small. However, even in countries in which foreign holdings of stock are relatively small (Table 4), they may still own a large fraction of the free float (the amount available for trading). In India, for example, while foreigners own 20 percent of Morgan Stanley Capital International (MSCI) stocks, and less of the total market, they hold over 80 percent of the MSCI free float.

Table 4.

Stock Holdings by Investor Type 1/

(In percent)

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Source: HSBC analysts, estimates at end-2005.

The numbers do not add to 100 percent because ownership by government, banks and corporates are omitted as they are generally longer-term holders and do not represent part of the free float.

Financial Integration

Controls on foreign investor participation in equity markets have been loosened over time. Since the early 1990s, economies such as Taiwan Province of China, Thailand, and Korea have been gradually raising caps on portfolio investment by nonresidents, with Taiwan Province of China completely eliminating these caps in 2003. Australia, Hong Kong SAR, Japan, and Singapore are relatively open to cross-border equity flows by nonresidents. By contrast, access is generally restricted to qualified or foreign institutional investors5 in China and India, and the extent of participation is limited by quantitative caps. As a general matter, however, the share of Asian market capitalization that is investable according to the S&P/IFC (a measure proposed by Edison and Warnock (2003) to measure market openness) has trended upward since the early 1990s, consistent with equity market liberalization.

Figure 9.
Figure 9.

Equity Market Integration 1/

(Share of S&P/IFC Investable in percent of S&P/IFC Global)

Citation: IMF Working Papers 2006, 266; 10.5089/9781451865264.001.A001

Sources: Datastream; and IMF staff calculations.1/ End-period. End June data for 2006. The measure follows Edison and Warnock (2003). S&P/IFC Investable equities are a subset of S&P/IFC Global equities, and exclude shares that are not legally accessible by foreign investors.
Table 5.

Restrictions on Cross-Border Portfolio Investment in Asia, 2005

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Source: Asia Bond Monitor, 2005; and IMF Annual Report on Exchange Arrangements and Exchange Restrictions, 2005.

Intraregional equity portfolio flows nearly tripled over 2001–04 to $113.6 billion. Today, intraregional flows account for over 15 percent of total inflows to countries in the region, up from just under 10 percent in 2001 (Table 6). However, these flows are derived from a relatively few countries (mainly the financial centers of Hong Kong SAR, Singapore and Japan). Furthermore, intraregional flows by some measures remain small relative to flows from Asia to the rest of the world. For example, Japan, one of the largest sources of portfolio flows in the region, channels about 7 percent of its external portfolio investment to Asia. Also, cross-listings within the region by and large remain modest (Box 1).

Table 6.

Cross-Border Equity Security Investment, 2004

(In billions of U.S. dollars)

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Source: IMF, Coordinated Portfolio Investment Survey.

Cross-Listings and Equity Market Integration in Asia

Cross-listing1 can be thought of as a channel for individual companies to achieve integration with global capital markets. Investors can hold foreign equities easily via domestic exchanges. Issuers can benefit from an expanded shareholder base and lower risk premiums; access to more developed capital markets and lower cost of capital; increased liquidity; better information disclosure and coverage by analysts; and better corporate governance.2

Companies in several of Asia’s largest countries have significant cross-listings. For example, companies from mainland China issue in the Hong Kong SAR market. Companies from India often list on London and other European exchanges. Economies with major exporters and multinational companies (Korea and Taiwan POC) cross-list actively on U.S. and European bourses.

Most of the cross-listing by Asian companies occurs through developed exchanges in the United States and Europe, not within the region, with the key exception of the China-Hong Kong SAR link. This fact might simply reflect the dominance of established bourses, which are recently strengthening owing to mergers and alliances.3 It could also partly reflect restrictions on cross-listings in some Asian countries; for instance, foreign companies (except for those from mainland China) must be locally incorporated to be listed in Hong Kong SAR.

Equity Issuances 1/

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Sources: Dealogic; EMDB; CEIC; and Fund staff calculations.

Including Depository Receipt issuances. 2006 data includes end June.

Local issuance data include up to end 2005.

Excluding July 2005 domestic offering data for Malaysia.

1/ Including direct listings (as often used by Canadian and Israeli firms in the United States) and depository receipts (DRs). A DR is a certificate issued by a depository bank for a foreign security that is held by the depository’s custodian in the home market.2/ D. Miller (1999), “The Market Reaction to International Cross Listings: Evidence from Depository Receipts,” Journal of Financial Economics, Vol. 51.3/ For example, the Paris, Brussels, and Amsterdam exchange merged to form Euronext in 2000, which then announced a merger deal with the New York Stock Exchange in 2006. NASDAQ raised its stake in the London Stock Exchange to 25 percent in 2006.

Growing Domestic Institutional Investor Base

Domestic institutional investors have emerged as a relatively new driving force in Asian equity markets. Between 2000 and 2004, domestic mutual finds, pension funds and insurance companies’ assets doubled to just over 36 percent of emerging Asia GDP.6 In some countries, a large share of such companies’ assets is invested in equities. Nonetheless, the sector still holds major potential for growth, since it remains small relative to developed countries (U.S. institutional investors’ assets comprise 160 percent of GDP; McKinsey Global Institute, 2006a and 2006b).

While institutional investors play large roles in some markets, in some cases structural barriers may hinder their participation. In China, Indonesia, the Philippines, India, and Thailand, institutional investors’ assets on average account for under 15 percent of GDP, less than a third of that in better-developed markets. The growth of institutional investors seems to have been constrained by several factors (Ghosh, 2006):

  • Restrictions on the types of investments that can be made by insurance and pension companies (China, India, Indonesia, and the Philippines require institutional assets to be invested in government securities or bank deposits);

  • Competition from government guaranteed savings schemes (e.g., India’s small savings schemes);

  • Crowding out by public defined benefit pension plans (Korea, Philippines, and Thailand);

  • Legislative hurdles (e.g., outdated legislation hinders mutual fund development in the Philippines); and

  • The dominance of small players (for example, in Indonesia, Malaysia, the Philippines and Thailand, low capital requirements have left the insurance industry fragmented).

Accordingly, in such markets retail investors account for the bulk of exchange trading (about two-thirds in China, about 85 percent in India; McKinsey Global Institute, 2006a, b).

However, trends under way may spur growth of institutional investors in Asia. For example, several countries have begun to establish new pension systems. In December 2005, Korea allowed private companies to establish defined benefit or contribution systems, while in July 2005 Taiwan Province of China introduced a new Labor Pension Fund that has already amassed funds of NT$70 billion ($2.1 billion). Looking forward, Thailand and India also plan to establish new pension systems.

Controls on asset allocations of public institutional investors are also being progressively eased, in an effort to boost sagging returns. In 2005, China permitted the National Social Security Fund to begin investing in equities, while India allowed private provident trust funds to invest up to 5 percent of their assets. Since 2004, the National Pension Fund of Korea has been increasing its holdings of local equity with the aim to reaching 10.7 percent of assets by 2009. Allocations to equities are larger in some countries, 45 percent in Hong Kong SAR (Vittas, 2005) and 29 percent in the Philippines.

The removal of controls on mutual fund activities has also aided market development. In India, private competition was introduced into the mutual fund market in 1987, and foreign entry was first permitted in 1993. In Japan, Japan Post and private banks have recently been allowed to sell investment trusts to the public, and Korea has announced its long-term vision to become a regional financial hub with special expertise in asset management.

Improvements in Market Infrastructure and Governance

Efforts over the past decade have resulted in the region having some of the most technically efficient markets in the world (Table 7) and have also improved corporate governance. On the technical side, most countries in the region have developed electronic clearing and settlement systems. Steps have also been under way to enhance corporate transparency and to adopt global accounting and disclosure standards—which is important because corporate governance figures prominently in investment decisions.7 Formally, the rules and regulations governing corporate governance across the region are in general quite strong. That said, while there is little variation across Asian economies in (for example) legal rights of shareholders, there are differences in the requirements on disclosure and transparency and board responsibilities (Cheung and Jang, 2005). For example, Taiwan Province of China does not require disclosing shareholders that hold 5 percent of a company’s shares, but China, Malaysia, the Philippines, Singapore, and Thailand require disclosure of the top 10 shareholders in addition to any with stakes of 5 percent of more. Hong Kong SAR, Indonesia, Malaysia, and Singapore do not require disclosure of management shareholdings. In emerging Asia, only China, Malaysia, and the Philippines require continuing training of board directors.

Table 7.

Market Infrastructure Scores 1/

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Sources: GSCS; and Thomas Murray.

GSCS compares the settlement efficiency of markets, incorporating average trade size, local market interest rates, the proportion of trades that fail, and the length of time for which they fail. 100 represents the highest score. Thomas Murray produces ranking of post-trade risk exposures according to various criteria of clearing and settlement, safekeeping, and asset servicing. The ratings follow alpha scale form AAA to C.

Figure 10.
Figure 10.

Insurance Assets in 2004 1/

(In percent of GDP)

Citation: IMF Working Papers 2006, 266; 10.5089/9781451865264.001.A001

Source: Country regulators.1/ Philppines data are for 2002 and for South Africa 2003.2/ Assets mantained in Hong Kong SAR.
Figure 11.
Figure 11.

Change in Insurance Assets, 2000–2004 1/

(In percent of GDP)

Citation: IMF Working Papers 2006, 266; 10.5089/9781451865264.001.A001

Sources: Country regulators.1/ Philippines change between 2000 and 2002; South Africa between 2000 and 2003.2/ Assets retained in Hong Kong SAR.
Figure 12.
Figure 12.

Pension Fund Assets Under Management, 2004

(In percent of GDP)

Citation: IMF Working Papers 2006, 266; 10.5089/9781451865264.001.A001

Sources: CEIC Data Company Ltd; IMF, Monetary and Capital Markets (MCM) Department; and, National Regulators.1/ For China, accumulated balance of social security and pension fund.
Figure 13.
Figure 13.

Change in Pension Funds, 2000–2004

(In percent of GDP)

Citation: IMF Working Papers 2006, 266; 10.5089/9781451865264.001.A001

Sources: CEIC Data Company Ltd; IMF, MCM Department; and, National Regulators.
Figure 14.
Figure 14.

Mutual Funds Asset Under Management in 2004

(In percent of GDP)

Citation: IMF Working Papers 2006, 266; 10.5089/9781451865264.001.A001

Sources: Regional Regulators; IMF, MCM Department; and, HSBC.
Figure 15.
Figure 15.

Growth in Mutual Funds, 2000–2004

(In percent of GDP)

Citation: IMF Working Papers 2006, 266; 10.5089/9781451865264.001.A001

Sources: Regional Regulators; IMF, MCM Department; and, HSBC.

Surveys of investor perceptions suggest that still significant differences remain within the region in the implementation of corporate governance laws (Cheung and Jang 2005).8 Implementation is seen as weakest in China and the Philippines and strongest in Singapore and Hong Kong SAR. In addition, while accounting standards in most countries have improved, there is some evidence to suggest that enhancements to transparency have been more muted (see IMF, 2006 WEO, Box 2.2; and De Nicolo, Laeven, and Ueda, 2006).

II. Performance of Asian Emerging Stock Markets

This section examines three aspects of Asian emerging-market equity performance over recent years. First, it examines price performance relative to other markets, and considers some possible drivers. Second, it looks at recent trends in volatility and the possible relationship with capital account liberalization. Third, it explores correlations with global and regional markets, to provide a perspective on the integration of Asian markets with other equity markets.

A. Price Performance

Over the past five years, Asian emerging markets9 have outperformed mature markets but lagged other emerging markets. Overall, stock prices generally remain well below pre-Asia-crisis peaks, whereas equity indices in Latin America, emerging Europe, and the Middle East exceed their 1990s highs (perhaps boosted by higher commodity prices or expectation of EU accession).

The run-up in Asian stock prices has reflected a period of good economic fundamentals in the region. Economic growth has been strong in a number of countries, in the context of a robust global expansion, notwithstanding periodic spikes in oil prices. Moreover, corporate profits have been solid.

Figure 16.
Figure 16.

Equity Prices

(Jan. 3, 2000 =100 for MSCI U.S. dollar index (left scale), U.S. rate in percent (right scale))

Citation: IMF Working Papers 2006, 266; 10.5089/9781451865264.001.A001

Source: Bloomberg LP.

Rising Asian stock prices have also coincided with a period of low U.S. interest rates. U.S. interest rates affect Asian equities in part through portfolio choices of global investors; they provide a benchmark safe return for global investors and are used to discount future cash flows from equities.10 In addition, higher U.S. rates sometimes coincide with moves by global investors toward more defensive postures, sending riskier assets such as emerging Asian equities lower. As a third channel, changes in the U.S. monetary stance may signal a turning point in the U.S. economy, with potential implications for growth in its trading partners. Indeed, turning points in Asian equity prices do seem to correspond, albeit rather loosely, to shifts in U.S. short-term rates.

Amid the stock market boom, Asian emerging market equity volatility has remained a few percentage points above the levels attained in the first half of the 1990s (although it is below the late 1990s level). Looking at country-specific data, however, the increase seems to be mostly limited to Indonesia and Taiwan Province of China, and to a lesser extent Korea; indeed, volatility is below pre-crisis levels in a few other markets.

Table 8.

Equity Price Change Volatility 1/

(In percent)

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Sources: Bloomberg LP; and IMF staff calculations.

Annualized 3-month rolling standard deviation of daily price changes. Based on MSCI U.S. dollar index.

Higher volatility in some countries compared with the early 1990s could reflect the opening up of Asian markets to foreign investment, but evidence on this score is mixed.11 In principle, the increase in openness means that Asian markets are more exposed to global volatility and shifts in investor sentiment, and thus could be more volatile. However, while openness has increased in the markets where volatility has risen, it has also increased in markets where volatility is basically unchanged, or lower. Moreover, empirical research has not found clear evidence that liberalization increases volatility. Bekaert and Harvey (2000) find a small but generally insignificant increase in stock market volatility after capital market liberalization. Using pre-1996 data, Holmes and Wong (2001) found that liberalization lowered volatility, or did not raise it, in Singapore, Korea, and Taiwan Province of China. Hargis (2002), De Santis and Imrohoroglu (1997), and Claessens (1995) report similar finding for emerging markets in Latin America and Asia.

Overall, no systematic trend in volatility related to market opening seems to be evident.12 That said, the changes in volatility in selected Asian markets—as well as the contrast with developments in other emerging markets—remain to be explained.

B. Correlation with Global and Regional Markets

Asian equity markets have become more synchronized with global markets since the early 1990s. The same is true for emerging markets as a group, suggesting that globally rising integration may be at play. Indeed, Asia’s correlation with developed markets has moved closely with the overall emerging markets correlation. Correlations have also risen significantly for individual Asian countries, in some cases quite dramatically.13

Figure 17.
Figure 17.

Correlation with Developed Equity Markets 1/

(In 12-month rolling)

Citation: IMF Working Papers 2006, 266; 10.5089/9781451865264.001.A001

Sources: Bloomberg LP; and IMF staff calculations.1/ Based on MSCI U.S. dollar index 3 month MA of daily percent price change.
Table 9.

Correlation with Developed Equity Markets 1/

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Sources: Bloomberg; and Fund staff calculation.

Correlation is based upon 3-month MA daily price changes of MSCI U.S. dollar price index.

The Asian market “beta” versus world markets has also increased over time. In a standard, single factor capital asset pricing model, the “beta”—essentially the slope in a regression of the local market return on global market returns—is the appropriate measure of risk. In particular, it is the risk—and hence the expected return—associated with exposure to the overall (world) market. Notably, the beta for the S&P/IFC global index has risen by more than that for the investable index. This is consistent with the idea that rising market integration could be lifting return correlations. In particular, as the share of internationally tradable stocks in the global index rises, the share held in global portfolios should rise, and thus its exposure to global market developments should increase.

The uptrend in correlation and beta vis-à-vis global markets could reflect increased liberalization, but, as is the findings on volatility, the literature on this score is mixed. For example, Bekaert, Hodrick, and Zhang (2005) do not find evidence for an uptrend in return correlations, but also note that many studies find different results, in part because correlations are unstable over time (as shown in Longin and Olnik, 1995). In addition, Bekaert and Harvey (1995) suggest that even if greater integration increases the correlation of returns across countries, time variation in the degree of market integration could complicate the empirical relationship of asset prices, market liberalization, and market integration, making it difficult to attribute rising correlation directly to liberalization.

Figure 18.
Figure 18.

Emerging Asian Equity Beta vis-a-vis World Equity

(Five-year rolling estimates)

Citation: IMF Working Papers 2006, 266; 10.5089/9781451865264.001.A001

Sources: Datastream; and IMF staff calculations.

III. Are Asian Markets Overheating?

An examination of valuation measures and risk-adjusted performance can shed light on whether Asian markets may have become overheated. Measures such as price-earnings (PE) ratios (here, based on historical earnings) and dividend yields provide some sense of whether prices are broadly in line with the relevant underlying cashflows. Measures of risk-adjusted performance can help in gauging whether recent market performance has been unusual (if, for example, it is very high relative to comparator markets).

Table 10.

Price-Earnings Ratio 1/

(In period average)

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Sources: Datastream; and IMF staff calculations.

Based on MSCI country index

Highest annual average between 1990–97. Each economy can have different data starting point.

Historical high since 1995.

Table 11.

Dividend Yields 1/

(In period average)

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Sources: Datastream; and IMF staff calculations.

Based on MSCI country index

Lowest annual average between 1990–97. Each economy can have different data starting point.

Historical low since 1995.

Most Asian markets show historically moderate valuations. Even in cases where PEs exceed averages for earlier in this decade, PEs are generally much lower than pre-Asia-crisis highs. Dividend yields (dividend/price; a higher figure implies a more modest valuation) are similarly moderate, by and large. That said, a few markets (India, Sri Lanka) have valuations that are somewhat above recent averages.

The expected real dividend growth implied by current valuations also appears to be generally in line with medium-term GDP growth forecasts. A deeper look at valuations compares expected real dividend growth extracted from dividend yields with GDP growth as a simple benchmark. Heuristically, dividends should grow basically in line with GDP, if in the long run corporate earnings are stable as a share of GDP and dividends are stable as a share of earnings. Using the Gordon model to extract implied growth in real dividends and comparing it with real GDP forecasts from the WEO (Table 13) under various assumptions,14 in only a few instances (assuming high risk premiums) do equity-market valuations imply levels of dividend growth that are out of line with medium-term WEO projections. Even in these cases, they are not grossly above WEO growth projections.

Table 12.

Equity Valuation and Implied Dividend Growth Rate, 2006 1/2/

(In percent)

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Sources: Bloomberg LP; and IMF staff calculations.

Implied dividend growth rates are calculated following the Gordon valuation model: Pt = Dt (1+gt )/(rt + ρt - gt ); where Pt is equity price; Dt is dividend; rt is the real interest rate; gt is the real dividend growth rate; and ρt is the risk premium.

Calculations are based on average data from January-June 2006 unless otherwise specified. Short rate refers to yields of 3-month government or central bank bills, and long rate refers to 10-year bond yields. As for U.S. rates, only the results with short rate are shown as the ones with long rates are very similar reflecting flat U.S. yield curve.

Average of projected real GDP growth rate from 2006 to 2011, based on IMF (2006).

Real interest rates are calculated using headline CPI inflation.

250 basis points are added to roughly reflect EMBI global spreads.

Table 13.

Nonpublic Sector Investments in Equity Markets

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Sources: CEIC Data Company Ltd; CMIE, Business Beacon; China Human Development Report; Singapore Department of Statistics; and Monetary Authority Singapore.

For China, total wealth invested in all types of financial assets in 2002.

In Korea, foreign investors hold some 11.3 percent of GDP in Korean stocks. If these and the holdings of the government sector is included, total stock market assets in the economy is about 6 percent of GDP.

For Singapore, household and corporates holdings reported by the departments includes securities in addition to shares. To remove the securities component, the table assumes that the corporate sector share issue is equally divided between the financial and household sectors.

2004 for Singapore and Taiwan POC.

Ex-post risk-adjusted returns in EM equity investments also do not suggest that markets are overheated. Based on the Sharpe ratio, which measures excess returns per unit of risk (volatility, as measured by the standard deviation), Asian risk-adjusted returns have been basically in line with those in emerging markets in other regions, as well as U.S. high-yield bonds. This is consistent with analysis of excess returns (over a risk-free benchmark rate), which have been broadly similar to those in non-Asian emerging markets. As one important caveat, this does not provide definitive evidence, on its own, that Asian markets are not overheated—it cannot be ruled out that many markets are out of line with fundamentals. But along with the aforementioned valuation measures, it does provide some evidence that recent performance has not been grossly out of line with fundamentals.

Figure 19.
Figure 19.

Excess Return 1/

(In percent, period average)

Citation: IMF Working Papers 2006, 266; 10.5089/9781451865264.001.A001

Sources: Bloomberg LP; and IMF staff calculations.1/ Annualized daily excess return over 3 month U.S. treasury yields.2/ S&P/IFC investable indices in U.S. dollar, total returns.3/ Merrill Lynch bond index, total returns.
Figure 20.