The International Journal of Business and Finance Research ♦ Volume 4 ♦ Number 1 ♦ 2010 INTERNATIONAL TRANSMISSION OF STOCK RETURNS: MEAN AND VOLATILITY SPILLOVER EFFECTS IN INDONESIA AND MALAYSIA Trang Nha Le, Vietinbank Makoto Kakinaka, International University of Japan ABSTRACT This paper examines the mean return and volatility spillover effects from the three influential stock markets of the US, Japan, and China to the two emerging stock markets of Indonesia and Malaysia over the sample period from 2005 to 2007. By analyzing GARCH models, we verify that there are significant mean spillover effects from the three major markets to the two emerging markets. The magnitude of the mean spillover from the US market is the most significant compared to the Japanese and Chinese markets. This would be consistent with the conventional wisdom in which the US market is believed to be the most influential market in the world. In terms of the volatility spillover, the empirical results reveal that the US market is more influential to Indonesia, but less to Malaysia, and recently growing Chinese market has a significant influence to both of the two emerging markets. . JEL: F36; G15 KEYWORDS: Indonesian and Malaysian stock markets; mean and volatility spillover effects INTRODUCTION he Association of South East Asian Nations (ASEAN) has recently made tremendous progress toward economic integration through forming a free trade area (ASEAN Free Trade Area – AFTA) and an investment zone (ASEAN Investment Area - AIA). Even though the 1997 Asian financial crisis might have discouraged some fast-growing economies in the region, it has been widely acknowledged that financial integration with rapidly growing stock markets in the area plays a crucial role in achieving more efficient allocation of capital, and thus promoting economic development. The on-going liberalization of capital mobility along with technological progress of network systems has caused international financial markets to become highly integrated and interdependent. One important aspect of integration is international transmissions among stock markets, as anecdotes often emphasize co-movements associated with a significant impact of major markets. This paper provides some empirical evidences of international transmissions from major stock markets toward recently developing stock markets (Indonesia and Malaysia) in ASEAN. In particular, we examine the mean and volatility spillover effects of stock returns from the US and Japanese markets toward each of the two emerging markets, partly following the two-stage GARCH method as in Liu and Pan (1997). As an extension, we also incorporate the transmission from the Chinese market into the model. The reason for this extension is that the Chinese market seems to affect other emerging markets because of its large economic scale and impressive economic growth, as well as its close relationship with ASEAN countries in terms of trade and FDI. Given the fact that the stock markets in the region are attracting many investors with global portfolio diversification, understanding the interdependence of the stock markets would be crucial to implement appropriate financial policies. By using GARCH models, we first capture the residuals for the US, Japan, and China markets with the consideration of their interdependence. After that, the residuals are employed to analyze the international T 115