Dynamic Integration of Domestic Equity Price, Foreign Equity Price and Macroeconomic Indicators: Evidence from Malaysia

How does the extent of integration of the Malaysian equity market with the equity markets of Japan and USA vary at different time scales? How dynamic is the extent of co-movement of equity price with the major macroeconomic indicators of Malaysia? In order to answer these two major issues, this study attempts to investigate the dynamic integration of the Malaysian equity market with the equity markets of Japan and USA, along with the three major macroeconomic control variables: exchange rate, consumer’s price index (CPI) and industrial production (IP) of Malaysia. The methodology applied initially used the standard time series techniques such as, Johansen cointegration technique, vector error correction model (VECM), variance decompositions (VDCs), followed by the application of the recent dynamic rolling cointegration, Beveridge-Nelson (BN) time series decompositions and finally, wavelet coherence of time-scale decompositions on monthly data starting from February,1990. The study finds one significant cointegrating relationship, which could be an indication of incomplete integration process as evidenced in the dynamic rolling cointegration approach. VECM and VDC indicate that the Malaysian equity market appears to be more influenced by the Japanese equity market and CPI of Malaysia. BN decompositions evidence almost simultaneous co-movement of permanent and transitory components of all variables and the co-movement appears to be closer during the financial crises. Finally, the wavelet coherence suggests closer co-movement of the Malaysian equity market with the Japanese equity market, which tends to vary according to different time scales. The findings of wavelet coherence on co-movement of the equity prices at different time scales tend to be different from those of the standard time series techniques such as, VECM and VDCs. The results of the study have strong policy implications.