Financial Integration and International Diversification Benefits: Cross Country Evidence from a Malaysian Perspective

Abstract

A vast deal of research presenting evidence on the benefits of international diversification has been published. The empirical studies came to rather diverse conclusions as the authors used different sampling data, analyzed different countries within a different time period. The purpose of this paper is to analyze the degree of financial integration and benefits of portfolio diversification between the Malaysian equity markets and developed and developing equity markets from Malaysian perspective. The research question is; Is Malaysian financial market integrated to developed and developing markets? It inspects the controversial issues of market segmentation and integration in an emerging market setting, namely Malaysia. In the analysis, the developed and developing equity returns are adjusted for exchange rate fluctuations using Ringgit Malaysia based exchange rates. By employing time series analysis, the paper also seeks to investigate which market actually leads the Malaysian stock market. The research is based on secondary data, existing theories and earlier studies regarding international integration of stock market movements. The methodology utilizes standard co integration analysis, vector error correction model and portfolio theory. We also rely on variance decomposition and impulse response functions to gauge the strength of the interactions among the variables. This study contains secondary data for the period of 1999 to 2008.The study comprises monthly closing Morgan Stanley Composite Index (MSCI) indices of twenty developed and developing countries. The findings from the analysis could be useful to fund managers in their essential decision for portfolio management. The findings may also be of interest to policy makers interested in stock market co movement, since internationalization of markets could represent significant capital inflow or outflow and thus influence savings and consumption decisions.