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Closer, Ever Closer

From iMFdirect:

Here’s the good news: thanks to relatively strong fundamentals and good policies,  Asian economies have coped well with the global market turbulence of recent years. Now the bad: a major financial shock—say, of type ignited by the bankruptcy of U.S. investment bank Lehman Brothers in 2008—is likely to have a substantial impact on Asia.  The reason: Asia’s increasing financial interconnectedness.

Over the past two decades—in line with the region’s growing role in the global economy—Asia’s equity markets have become increasingly sensitive to global financial developments.   More specifically, we have discovered that equity returns in Asia generally now move in tandem with those in systemic economies.  (By systemic economies, we are talking here about those countries—such as the United States and the United Kingdom which are home to major, global, financial centers such as Wall Street and the City of London.)

How do we measure that degree of financial interconnectedness?  Or put another way, how do we measure the relationship—if any—between those Asian equity returns and the performance of systemic economies?


Tracking interconnectedness

The answer: by tracking Asian financial “betas” which measure volatility and capture the impact of the systemic economies on Asian equities.

These betas describe the fluctuations of those equities in relation to the fluctuations of the benchmark–in this case, the performance of large, systemic economies. A positive beta means that the asset’s returns generally follow the market’s returns, while a negative beta means that the asset’s returns are generally unmoved by the market.

Asian financial betas have followed a modest, but steady upward trend over the past two decades.  This is easily seen in a graph showing Asian financial betas and global financial shocks.

A spike on the graph—whether it represents the bursting of the technology bubble, or more recently, the turmoil in the euro area—is mirrored by a similar spike in Asian financial betas.


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