Parametric and nonparametric Granger causality testing: linkages between international stock markets

TThis study investigates long-term linear and nonlinear causal linkages among eleven stockmarkets, six industrialized markets and five emerging markets of South-East Asia. We cover the period1987—2006, taking into account the on-set of the Asian financial crisis of 1997. We first apply a testfor the presence of general nonlinearity in vector time series. Substantial differences exist between thepre- and post-crisis period in terms of the total number of significant nonlinear relationships. We thenexamine both periods, using a new nonparametric test for Granger non-causality and the conventionalparametric Granger non-causality test. One major finding is that the Asian stock markets have becomemore internationally integrated after the Asian financial crisis. An exception is the Sri Lankan marketwith almost no significant long-term linear and nonlinear causal linkages with other markets. To ensurethat any causality is strictly nonlinear in nature, we also examine the nonlinear causal relationships ofVAR filtered residuals and VAR filtered squared residuals for the post-crisis sample. We find quite a fewremaining significant bi- and uni-directional causal nonlinear relationships in these series. Finally, afterfiltering the VAR-residuals with GARCH-BEKK models, we show that the nonparametric test statisticsare substantially smaller in both magnitude and statistical significance than those before filtering. Thisindicates that nonlinear causality can, to a large part, be explained by simple volatility effects.