Volatility and dependence transmission in Asian equity and bond markets

Asymmetric and extreme dependence in Asian equity and debt markets: Existing research on international equity and bond markets have shown little evidence of asymmetric dependence between bonds and equities. Unlike stock markets, a priori, it is submitted that dependence structure between stocks and bonds is symmetric. This is because of the safe haven nature of bond markets where investors ‘flight to quality’ during episodes of market turmoil. Likewise, in an upswing, investors would switch back into risky assets and therefore, ‘flight from quality’. However, this study has found evidence of asymmetric dependence between foreign currency bonds and equities in Korea, Indonesia, and Philippines. For local currency bonds, foreign currency risk exacerbates asymmetric dependence with equities. As contrasting cases, Hong Kong and China, where exchange rates are stable have symmetric dependence between the two asset classes. Local currency bond markets in Indonesia and Philippines’ displayed asymmetric dependence with equity markets even when foreign exchange risk is completely removed through FX hedging. Tail dependence for foreign currency bonds and equities has been rising for some markets and this is partly due to increasing foreign participation and in some cases, such as China, changing composition of the bond market towards riskier issuers. In Korea, tail dependence has been declining reflecting the improvement in its credit fundamentals. In conclusion, outside of Indonesia and Philippines, the local currency market exhibits resilience against left tail risk for the domestic equity investor but not when currency risk is assumed for the foreign equity investor. For local currency markets, countries with tightly managed exchange rate regimes such as Hong Kong and China, have local currency bond markets that are relatively decoupled from the equity markets.