Fundamental and behavioural determinants of stock return volatility in ASEAN-5 countries

Highlights

• Fundamental factors play crucial roles in influencing stock market volatility in developed markets.

• Behavioural factors affect stock market volatility more significantly in developing markets.

• ASEAN-5 has made encouraging progress of integration in the region.

• Monetary policies play a more important role than fiscal policies in ASEAN.

Abstract

Fundamental and behavioural factors are the two determinants of stock prices but are rarely investigated simultaneously. This paper examines the role of fundamental and behavioural factors in stock return volatility in the Association of Southeast Asian Nations-5 countries (ASEAN-5) for the period of January 1995 to December 2018 comprising three regimes (before Asian, between Asian and Global, and after Global financial crises). We find that fundamental factors play crucial roles in influencing stock market volatility in Malaysia, Thailand, and Singapore; whereas, behavioural factors affect stock market volatility more significantly than fundamental factors in Indonesia and the Philippines. We find distinctive differences across the three regimes supporting the above findings. Further our results suggest that ASEAN-5 has made encouraging progress of integration with Malaysia and Thailand being closer to Singapore in terms of economic development, corporate values, and political stability; however, Indonesia and the Philippines are much behind showing economic instability and their vulnerabilities are especially associated with the timing of the Asian and global financial crises. Our findings also suggest that monetary policies play a more important role than fiscal policies in the region and highlight a number of policy implications.

Introduction

Fundamental factors are derived from conventional finance theory on the assumption that investors follow basic financial rules and design investment strategies purely based on the risk-return consideration (Baker et al., 1977). Fundamentally different from rational expectation hypothesis, behavioural finance asserts that investors are ordinary people influenced by sentiment and psychological prejudices, that markets are inefficient, and that differences in expected returns are decided by more than the differences in risk (Statman, 2014). Behavioural factors better explain the observation of stock markets that many investors make decisions following good/bad news, or other factors, e.g. herding, loss aversion. These ‘noise’ traders make stock markets informationally inefficient, and this leaves arbitrage pricing theory (the cornerstone of conventional finance) with a limited role to play (De Long et al., 1990, Shleifer and Summers, 1990). Therefore, fundamental value and sentiment are the two driving forces of stock price movements. Stock prices reflect actual value only when markets are efficient and traders have full information; however, in real-world, irrational noise traders play a crucial part in influencing stock prices and sometimes their roles are even more significant than the latter (Fisher and Statman, 2000, Fisher and Statman, 2004). As pointed out by Subrahmanyam (2007), “The evidence in favour of inefficient financial markets is far more compelling than that in favour of efficient markets” (cited in French, 2017, p. 129).

Studies of fundamental and behavioural factors are often conducted separately in either developed or emerging markets, with more studies of fundamental factors linked to developed markets, while more behavioural studies are found for emerging markets (Baker and Wurgler, 2006). Emerging and developed markets have distinctive characteristics in terms of types of financial products, the extent of risk-return and volatilities, and financial certainty/uncertainty (Kumari and Mahakud, 2015). Arguably, a study that investigates how fundamental and behavioural factors influence decisions in a regional stock market that includes both developed and emerging countries would enhance our knowledge as to how the market work, which will stimulate further research. This is because such a study can capture the natures of how these two types of factors would interact in the regional market and its integration of this market.

We argue that the stock markets of the Association of Southeast Asian Nations (ASEAN) are an appropriate location for such a study. First, the Southeast Asia region, which comprises five original member countries, namely Singapore, Malaysia, Indonesia, the Philippines and Thailand, has experienced rapid economic growth for decades. Investors tend to seek higher returns from stock markets in this region, which are subject to high volatilities in the meantime. These features thus provide an ideal case for examining the impact of macroeconomic and corporate factors (i.e. fundamental factors). Second, the Southeast Asian stock markets are more speculative than other developed regional markets such as those in the US and Europe (Lu et al., 2018); hence, there is a greater prevalence of noise traders in this regional market, which provides us with an opportunity for assessing the influence of behavioural factors. Third, the ASEAN-5 contains both developed and developing markets,¹ with Singapore well known to be a developed (though small) market, while the other four are generally recognised to be emerging markets. Given these features, it would be possible to explore what roles fundamental and behavioural factors play in the regional market. Finally, and most importantly, the ASEAN region has been undergoing integration and a significant number of studies have discussed the extent to which this has been achieved. For example, Click and Plummer (2005) examine stock market integration in ASEAN-5 after the 1997 Asian financial crisis using time series cointegration technique and conclude ASEAN-5 are integrated to some extent in the economic term. Similarly, using stock indices, Goh et al. (2005) investigate the intertemporal linkages of the ASEAN-5 responding to 1997 Asian financial crisis and suggest that ASEAN-5 experienced a structural change after mid-1997, while Indonesia led the movements. Lim (2009) also look at whether ASEAN-5 stock markets have correlations and long-run relationships between 1990 and 2008 and reveal signs of converging and integration after the 1997 Asian financial crisis. Truchis and Keddad (2013) find ASEAN-5′s monetary integration by examining generalised purchasing power parity and support further monetary integration as ASEAN-5 share long-term co-movements. These studies explore the stock market integration of ASEAN-5 from different angles; however, none of them is done from the perspective of how fundamental and behavioural factors influence stock return volatility. Thus, our investigation, which investigates the two factors in one study, will add a new dimension and fresh evidence to the integration debate; if they behave in a similar way across all sub-group countries in long-run, it suggests that the degree of the regional market integration is high; conversely, the integration level is low.

Our research examines fundamental and behavioural determinants of stock return volatility in ASEAN-5, including Indonesia (Jakarta Stock Exchange Composite Index: JKSE); Malaysia (Kuala Lumpur Stock Exchange Composite Index: KLSE); the Philippines (The Philippine Stock Exchange Index: PSE); the Thailand (Stock Exchange of Thailand Index: SET); and the Singapore (Straits Times Index: STI). We examine monthly data covering the periods from January 1995 to December 2018 (24 years). This extensive period includes the Asian Financial Crisis of 1997/98 and the Global Financial Crisis of 2008/09. In order to capture the specific feature, we examine market volatility across three sub-periods: Regime I (from January 1995 to December 1997), Regime II (from January 1998 to June 2008), and Regime III (from July 2008 to December 2018) based on the structural breaks in the Unit Root tests. We adopt an Exponential Generalised Autoregressive Conditional Heteroskedasticity (EGARCH) model to estimate the magnitude of return volatility, and an Autoregressive Distributed Lag (ARDL) model to examine the short-run dynamics and long-run relationship between the variables. Our findings reveal that the fundamental factors affect stock market volatility more significantly in Malaysia, Thailand, and Singapore than in Indonesia and the Philippines; while behavioural factors, conversely, affect stock market volatility considerably more in Indonesia and the Philippines than in Malaysia, Thailand, and Singapore. The results demonstrate that Malaysia and Thailand have greater similarities to Singapore, whereas the opposite is true in the case of Indonesia and the Philippines. Arguably, this is because Malaysia and Thailand are more integrated with Singapore and become more developed emerging (also called ‘catch-up’) stock markets; while Indonesia and the Philippines are not integrated to the same degree.

This paper makes three contributions to the existing literature. First, unlike other studies, which examine the impact of either fundamental or behavioural factors on stock return volatility in a single market (either a developed or developing country), we combine the two types of determinants in a regional market – the ASEAN-5 - including both developed and emerging countries. This novel perspective captures how, and to what extent, the two factors affect stock return volatilities in this regional market. Moreover, our data spans 24 years and incorporates both the Asian and global financial crises divided into three Regimes. We identify distinctive differences across the three regimes, i.e. fundamental factors are stable and associated with Malaysia, Thailand and Singapore across all Regimes; however, behavioural factors are linked to Indonesia and the Philippines showing inconsistent across three Regimes, which gives the assurance of our main finding. Second, our findings also offer fresh evidence to support arguments for the integration progress of the ASEAN-5, with the reasons behind this assessment being contextually discussed. Third, our findings shed light on the importance of the region’s financial policy on the market movements. In particular, monetary policies play a more critical role than fiscal policies in the region.

The remainder of this paper is organised as follows: Section 2 reviews the literature and formulates the hypotheses; Section 3 introduces methodological issues; Section 4 presents and discusses the empirical results; Section 5 contextualises discussions; and Section 6 states our conclusions.