Tao Liu, Central University of Finance and Economics:

## 1.  Introduction

This paper evaluates the degree of financial integration in Asia, from the perspective of currency markets. This topic is important for both academic research and policy analysis. There has been a long-standing debate on the cost and benefit of financial opening and capital account liberalization. Counter-cyclical financial flows help a country smooth consumption and improve the social welfare. Cyclical financial flows, however, would increase the volatility of output and consumption, making it more difficult for central banks to manage the economy. It is therefore important to first examine the status quo of financial market integration before governments make decisions on capital account liberalization. This issue has particular urgency and importance for ASEAN countries, given the catastrophic Asian financial crisis in 1997.

The authors rely on the variance decomposition in Diebold and Yilmaz (2014), as well as the pairwise Granger causality test in Billio et al. (2012) to carefully study the financial linkage among several important East Asia countries, including China, Indonesia, Japan, Korea, Malaysia, the Philippines, Singapore, and Thailand. Their data include the daily exchange rate returns of these countries’ currencies against the U.S. dollar (US$). The econometric analysis shows that the Singapore dollar (SGD) is the top contributor in East Asia currency markets. The network approach to financial spillover is an active field of academic research. Diebold and Yilmaz (2009) first proposed this measure of financial asset interdependence, mainly based on the variance decomposition in vector autoregression (VAR). Diebold and Yilmaz (2012) refined this method with generalized VAR so as to address the issue of variable order. Diebold and Yilmaz (2014) further advanced this approach and compared it with network measures. A careful study of East Asia currency markets through the lens of this innovative measure definitely sheds new light upon this classic topic. ## 3. Comments Notwithstanding this paper's careful research design and insightful results, there are several concerns that need to be addressed, possibly in the authors’ future work. First, the criteria of currency selection should be clarified. Specifically, the authors did not include US$ or Euro (EUR) in their empirical exercise. As a consequence, only 23.63 percent of the variation on average is explained by systemic interaction. This suggests that outside currencies such as EUR and US$might play a bigger role in accounting for the exchange rate movement in East Asia currency market. In addition, adding outside currencies would prove helpful, given that East Asian countries still peg to the US$ to some degree. Of course, the expression of exchange rate returns would have to be changed following the inclusion of US\$, and I suggest expressing the exchange rate against Swiss franc or Special Drawing Rights.

Second, the SGD is found to be the leading net contributor to the system, and this finding remains robust with alternative econometric specifications. Nevertheless, the authors failed to provide detailed economic explanations for this result. Why is Singapore so important in this aspect? Does this mean Singapore is more connected to other East Asian countries in economic and financial activities? Or, does this mean that the SGD is the regional currency whereas other currencies such as the Japanese yen are more important outside this region? More explanation and discussion would be helpful here.

Lastly, the network approach to financial spillover does not study the co-movement of exchange rates in this paper. It is therefore difficult to know whether the SGD, the leading net contributor in the system, behaves in a cyclical or counter-cyclical manner. A counter-cyclical movement of exchange rate provides more hedging opportunities for investors and helps stabilize the regional currency market, whereas a cyclical movement usually exacerbates the situation in times of crisis. Thus, it is not yet clear whether the SGD is contributing to the stability or instability of the system, and that needs to be carefully examined in future research.

## References

Billio
,
Monica
,
Mila
Getmansky
,
Andrew
W
.
Lo
, and
Loriana
Pelizzon
.
2012
.
Econometric Measures of Connectedness and Systemic Risk in the Finance and Insurance Sectors
.
Journal of Financial Economics
104
(
3
):
535
559
.
Diebold
,
Francis X.
, and
Kamil
Yilmaz
.
2009
.
Measuring Financial Asset Return and Volatility Spillovers, with Application to Global Equity Markets
.
Economic Journal
119
(
534
):
158
171
.
Diebold
,
Francis X.
, and
Kamil
Yilmaz
.
2012
.
Better to Give Than to Receive: Predictive Directional Measurement of Volatility Spillovers
.
International Journal of Forecasting
28
(
1
):
57
66
.
Diebold
,
Francis X.
, and
Kamil
Yilmaz
.
2014
.
On the Network Topology of Variance Decompositions: Measuring the Connectedness of Financial Firms
.
Journal of Econometrics
182
(
1
):
119
134
.