RDP 2001-03: The Response of Financial Markets in Australia and New Zealand to News About the Asian Crisis 5. Conclusion

This paper contains several findings on the response of financial markets in Australia and New Zealand to the events of the Asian crisis.

Australia's and New Zealand's stock markets and exchange rates tended to be more volatile on days in which significant news occurred in Asia than was true for other days in the Asian crisis period. Days adjacent to news-event days also tended to be more volatile than other days in this period. This was not the case for the bond markets, which were most volatile in the pre-crisis period encompassing the global bond market sell-off in 1994.

In general, Australian and New Zealand financial markets were positively correlated with Asian news events. Good news tended to be associated with rising stock prices and appreciating exchange rates, with the reverse being true for news events that we classified as bad. This could be interpreted as the financial markets' response to events in trading-partner countries that could influence export demand and domestic corporate profitability.

Once we controlled for overnight developments in US markets, however, the Asian news events appeared to have very little independent effect on Australian and New Zealand stock markets. Foreign exchange markets reacted with a one-day lag. It is possible that some of these events occurred after the close of the Auckland and Sydney trading sessions, so that markets here could only react after their US counterparts. Alternatively, financial markets may have processed the information inefficiently, by waiting for the US markets to react; daily movements in US markets are clearly important determinants of daily returns in Australian and New Zealand markets for all three asset classes. Although markets in Australia and New Zealand reacted with a lag to the news dummies, they had a contemporaneous relationship with Asian financial markets. This suggests that the timing explanation might be closer to the truth.

Our results do not suggest that spillover of volatility in stock and bond markets is necessarily greater during crises than in more normal times. The greater volatility in the Asian crisis period was simply due to the original shocks being larger than in the rest of the sample period. By contrast, volatility spillover in foreign exchange markets did appear greater in the Asian and world crises than at other times. This result suggests that trade linkages influence the investment decisions of market participants, as well as the global shocks that characterised the world crisis period.

In addition to our findings on responses to events in Asia, the results in this paper allow us to compare market behaviour in Australia and New Zealand at a more general level. Markets for the same assets in the two countries tend to behave more similarly than markets for different assets in the same country. The dynamic responses of bond prices and exchange rates to shocks originating in Asia are similar in the two countries for each asset class. There were some differences in the stock market responses, with the impulse response for New Zealand being more drawn out in the Asian crisis period. There was a cumulated divergence in the levels of the two countries' stock markets during the Asian crisis, and a small divergence in the levels of their exchange rates during the world crisis and post-crisis periods. However, there is no evidence of a systematic difference in responses to Asian news events or financial-market developments. This suggests that country-specific factors, such as the different operating regimes for monetary policy pursued during the crisis periods, were not important determinants of financial markets' reactions to shocks originating from abroad.