Modeling regional linkage of financial markets

Weihong Huang and Zhenxi Chen

Journal of Economic Behavior & Organization, 2014, vol. 99, issue C, 18-31

Abstract: With the development of globalization and regional economic integration, regional markets linked with a common currency emerge, in which investors from domestic market are allowed to trade in foreign markets. Empirical studies have evidenced extensively the existence of co-movement of asset prices or cross-correlation in market returns among these markets, especially in global event. However, there is no theoretical model in literature that can provide economically plausible justifications for these stylized facts. This research intends to fill up such a gap with a simplest possible nonlinear dynamic model. Based on the classical market-maker framework of Day and Huang (1990), a two-market HAM model is developed, which does not only prove in theory the existence of price co-movement but also replicate in simulation this typical characteristic, along with other well known stylized facts characterizing individual financial market. Moreover, theoretical analysis suggests meaningful implications for market opening policy. In particular, in terms of financial stability, a relatively small market may not benefit from market linkage and market opening is essentially a double-edged sword.

Keywords: Financial multi-market interactions; Market integration; Market maker; Market linkage; Chaos; Heterogeneous beliefs (search for similar items in EconPapers)
JEL-codes: C61 D84 G15 (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (16)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jeborg:v:99:y:2014:i:c:p:18-31

DOI: 10.1016/j.jebo.2013.12.009

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