Parametric and nonparametric Granger causality testing: linkages between international stock markets

TThis study investigates long-term linear and nonlinear causal linkages among eleven stock
markets, six industrialized markets and five emerging markets of South-East Asia. We cover the period
1987—2006, taking into account the on-set of the Asian financial crisis of 1997. We first apply a test
for the presence of general nonlinearity in vector time series. Substantial differences exist between the
pre- and post-crisis period in terms of the total number of significant nonlinear relationships. We then
examine both periods, using a new nonparametric test for Granger non-causality and the conventional
parametric Granger non-causality test. One major finding is that the Asian stock markets have become
more internationally integrated after the Asian financial crisis. An exception is the Sri Lankan market
with almost no significant long-term linear and nonlinear causal linkages with other markets. To ensure
that any causality is strictly nonlinear in nature, we also examine the nonlinear causal relationships of
VAR filtered residuals and VAR filtered squared residuals for the post-crisis sample. We find quite a few
remaining significant bi- and uni-directional causal nonlinear relationships in these series. Finally, after
filtering the VAR-residuals with GARCH-BEKK models, we show that the nonparametric test statistics
are substantially smaller in both magnitude and statistical significance than those before filtering. This
indicates that nonlinear causality can, to a large part, be explained by simple volatility effects.