Ripple Effects of the US-China Tension on Asian Emerging and Frontier Markets with Portfolio Implications

Abstract

In this paper, we investigate the ripple effects of the US-China tension on Asian emerging markets (India, Indonesia, South Korea, Malaysia, Philippines, Taiwan, and Thailand) and Asian frontier markets (Bangladesh, Sri Lanka, Pakistan, Bahrain, Kuwait, Vietnam, and Oman) for the period spanning from February 2013 to February 2024. The US-China Tension Index (UCTI) is a proxy variable for the US-China tension. Time-varying parameter vector autoregression, wavelet coherence, and hedging effectiveness techniques are employed for the empirical analysis. Findings show that the total connectedness between UCTI and Asian frontier markets is stronger than that of Asian emerging markets. Moreover, findings reveal that, in the case of Asian emerging markets, Indonesia, South Korea, Malaysia, Philippines, Taiwan, and Thailand are net transmitters of return spillovers, while India is a net receiver. In the case of Asian frontier markets, we find that Sri Lanka, Bahrain, Pakistan, Kuwait, and Oman are net transmitters. At the same time, Bangladesh and Vietnam are net receivers of return spillovers. In the frequency co-movement analysis, we report a positive correlation between UCTI and these markets at lower frequencies. In comparison, we report a negative correlation at the middle and higher frequencies. Furthermore, we report that hedging ratios highlight the significance of modifying portfolio weights in uncertain times when looking for investment opportunities in Asian emerging and frontier markets. Similarly, our findings highlight important implications for investors and portfolio managers to optimize their investments with risk-adjusted portfolios.