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The purpose of this study is to investigate the effects of a decade of financial deregulation on stock markets in term of market integration within Asia-Pacific countries. It investigates the existence of inter-relationships between five emerging and two developed stock markets in the region. Then, it examines the 'causal' relationships between each market and its country's economic fundamentals. The study is comprised of three major sections of empirical analysis: In the first section, three tests, correlation coefficients, unit root tests, and cointegration tests, are used to examine the short-term as well as long-term changes in the co-movement patterns of Asia-Pacific stock markets before and after financial deregulation. The second section employs VAR model to estimate and analyze the dynamic interdependencies among Asia-Pacific stock markets and trace out the effects of shocks to those markets. It also examines whether there is one or more dominant or particularly influential market within the region. Finally, the third section investigates the existence of interactions between stock returns and domestic economic fundamentals by applying causality tests. It focuses on the predictive content of historical information of stock returns in explaining economic variables, and hence, it tests whether the economic variables do or do not Granger-cause stock returns, and vice versa. The study provides a number of interesting and important results which can help us to understand the nature of stock market integration as well as evolution of financial integration in this increasingly important region. The study suggests that financial liberalization has enhanced the inter-relationships among Asia-Pacific stock markets, and that therefore high capital controls account for instances of low interactions. The study shows that the effects of a shock to stock markets are completed within two days, indicating that stock markets adjust quickly, but not instantaneously, to all relevant information in the region. The study also finds that Japan and Hong Kong are the most influential markets in terms of their effects on other markets in the region. Moreover, the result of the absence of cointegration may simply rule out the existence of a long- run equilibrium tending relationship, but does not invalidate any short-run relationships which may arise due to profit-seeking opportunities in transactions. Furthermore, examining the 'causal' relationships between a stock market and economic fundamentals shows that the exchange rate and the corporate bond rate are the only two out of several factors tested that are 'causal' of stock returns in many markets in the Asia-Pacific region. In short, the results are consistent with the view that stock returns only respond to monetary variables. Hence, one possible implication is that most of the indicators of macroeconomic fundamentals in the Asia-Pacific region are not the predictors of stock returns and that information captured in a stock market does not reflect changes in its country's macroeconomic fundamentals.
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