Return, Volatility and Short-term Capital Inflows: A Test of "Return-Chasing" Hypothesis in Asia-Pacific Equity Markets

Anthony H. Tu and Shen-Yuan Chen
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Anthony H. Tu: National Chengchi University, Taipei, Taiwan, ROC
Shen-Yuan Chen: National Chiao Tung University, Hsinchu, Taiwan, ROC

Review of Pacific Basin Financial Markets and Policies (RPBFMP), 2002, vol. 05, issue 03, 321-342

Abstract: The increased flows of securities investment have shifted from developed countries to emerging ones over the last decade. Capital flows to developing countries have important benefits. However, large surges in short-term and potentially reversible capital flows can have very negative effects. The idea of this study is to assess the empirical evidence in Asia-Pacific developed and emerging markets for whether the "return-chasing" hypothesis is true? The conditional variance in the model is assumed to follow a generalized ARCH-M model, including country credit ratings as explanatory risk variables in the mean and variance equations. The results suggest that the relationship between country index returns and return variance are weak for both developed and emerging markets. The changes of country credit ratings have positive impacts on country index returns in some Asian emerging markets, but not in developed markets. We also found that the changes of country credit ratings have significant influence, but with mixed sign, on country index return volatility for some Asian emerging markets, but not for developed markets. The findings support the "return-chasing" hypothesis, in which the flow securities investment tends to move into the markets whose returns are expected to be high and retreat from markets whose returns are predicted to be low. The result suggests that the world community and national authorities have to manage these flows more effectively. There exists a serious risk that such volatile flows could undermine the benefits that globalization and free markets can otherwise bring.

Keywords: Country credit risk; GARCH-M model; Return-chasing hypothesis; Return and volatility (search for similar items in EconPapers)
JEL-codes: G1 G2 G3 (search for similar items in EconPapers)
Date: 2002
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DOI: 10.1142/S0219091502000808

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