Hang Seng

Ever since the policy decision of Deng Xiaoping in '92 concerning the economic restructuring of China, the Chinese economy has become a prominent player in the global economy. The opening of the domestic market to foreign investors has created a tremendous rise in GDP (average annual growth of 9.5%). The People's Republic has made significant progress towards integration with the world economy over the past decade. China is characterised by its fixed exchange rates, keeping their currency undervalued involving a major annual increase in exports and thereby creating current account surpluses (export - led growth). Due to their financial restructuring of the nineties the Chinese financial markets have become more integrated into the global financial market. These developments are anticipated to have crucial implications for the behaviour of the Chinese stock markets (Hang Seng). Meanwhile, the US remains the most prominent player in the global financial economy. Therefore it is important to enlighten the behaviour of the Chinese stock market (Hang Seng) compared to the US stock market (S&P500) through the analysis of co movements. The inclusion of the S&P500 is important for two reasons. First, the US market serves as a reasonable proxy for the mature stock market respectively in depicting possible linkages with the emerging Hang Seng stock market. Second, due to investment and trade flows the S&P500 is expected to play an influential role in international stock market movements. Stock markets co movements may have considerable repercussions for equity market risk, asset valuation and portfolio allocation. If for instance, stock markets are co integrated they would exhibit a stable long term relationship, implying limited diversification benefits for international investor portfolios.

Therefore it is important to analyse the impact of the economic reforms in China on the financial markets by dividing the relevant period into two parts. The first period concerns 1987 - 1999 and not 1992 due to the fact that financial reforms only started at the end of the nineties. The second period regards the era after the financial reforms up till now (2007).

The analysis of co movements begins with the examination of the data generating process for each index. First, the "random walk with drift" - model will be estimated for both indices. The interpretation of the "random walk with drift" - model is very important in order to understand the movements of each index separately. The statistical properties of the residuals of the "random walk with drift" - model will be studied. Next,