Volatility Spillover Between The Chinese And Australian Stock Markets

Wei Chi

Monash University – Department of Accounting and Finance

Robert D. Brooks

Monash University; Financial Research Network (FIRN)

Emawtee Bissoondoyal-Bheenick

Monash University

December 2, 2015

Abstract:

Despite the increasingly tight economic relationship between China and Australia, little attention has been paid to the analysis of stock market volatility spillover across these two countries. This paper, based on industry data, fills the gap in the literature and provides a clear idea of the channels through which volatility is transmitted across countries. This paper finds that the volatility spillover across these two markets is bidirectional while there is single or insignificant spillover across industries between these two countries. More specifically, the results of the Granger causality test show that the stock market volatility spillover is bidirectional between these two markets in the financial, health care, industrials, information technology, and materials industries. One-way volatility spillover exists in the consumer staples industry and there is insignificant volatility spillover in the energy, telecommunications, and utilities industries between the Chinese and Australian stock markets.

Volatility Spillover Between The Chinese And Australian Stock Markets – Introduction

Analyzing volatility spillover is important, since it can help examine information flows and the mobility of shocks from one market to another. This topic has been discussed extensively in the literature in the context of the Chinese stock market. However, no study focuses on the volatility spillover between the Chinese and Australian stock markets based on their tight economic relationship that has recently evolved due to the Chinese economy’s high reliance on Australian resources. This paper, therefore, aims to fill this gap by examining the volatility spillover between the Chinese and Australian stock markets based on the latest industry data and realized volatility (RV) estimations.

Australia is rich in natural resources. Its economic prosperity has been mainly driven by exporting its natural resources. Its location is also close to China. Therefore, over the last two decades, the economic relationship between China and Australia has become closer and closer, as China has come to rely heavily on Australia’s mining and resources for its strong growth. Currently, China is Australia’s biggest trade partner. Australia is also importing a large amount of products from China. Further China being the second biggest economy, there is no ignoring the fact as the Chinese economy faces any volatility or downturn, other countries, whether developed or emerging will not be unaffected. Hence, given the close relationship between China and Australia, stock market volatility is expected to spillover across these two countries. Some studies discuss the volatility spillover between China and some developed countries, such as those of Zhu et al. (2004) and Qiao et al. (2008), who discuss the volatility spillover between the Hong Kong and Shanghai stock markets, and Nishimura and Men (2010), who find one-way volatility spillover from China to the U.S., U.K., German, and French stock markets, while Hu et al. (1997) discuss the influence of the volatility of the U.S. stock markets on China. Johansson and Ljungwall (2009) find that, due to growing economic ties and economic cooperation, stock market spillover effects among China, Hong Kong, and Taiwan are becoming stronger. However, the high interdependence between Australia and China has received little research attention to date. Kim et al. (2015), assess the spillover effect of the US financial crisis on financial markets on Asian countries. They find evidence of some financial contagion, their study does not include China. The importance of analysing the spillover effect on/from the Chinese economy has been has been clearly felt and reinforced by the worldwide stock market turmoil in August/September 2015. While China has been the shepherd protecting Australia over the global financial crisis, the weakening of the Chinese economy has severe implications for Australia.

Since December 2014, China has become the largest economy in the world overtaking the US in real GDP. Due to rapid economic development, the relationship between China and Australia has been closer, since China heavily relies on Australia’s mining and resources for strong growth. China has become Australia’s biggest trading partner and Australia is China’s sixth largest trading partner. China’s share of Australia’s total merchandise trade was below 5% before 2000 but jumped to about 25% in 2012 (Department of Foreign Affairs and Trade of Australia, or DFAT, 2012). According to the DFAT’s 2014 China fact sheet, total imports of merchandise trade from China to Australia is relatively stable, around AU$40 billion, while exports of merchandise trade from Australia to China increased from AU$25 billion in 2007 to about AU$94 billion in 2013 (see Figure 1).

volatility

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