VOLATILITY OF RETURNS, TRADING VOLUME AND THE IMPACT OF MACROECONOMIC ANNOUNCEMENTS: HIGH-FREQUENCY EVIDENCE FROM THE INDONESIAN STOCK MARKET Haryadi Master of Business (Banking and Finance) College of Business, Victoria University Melbourne, Australia Submitted in fulfilment of the requirements of the degree of Doctor of Business Administration November 2016 ABSTRACT A great amount of research has been undertaken into the patterns of, and the contributing factors to, the volatility of emerging equity market returns. One of the most common findings in the research is that the volatility of emerging market returns is high compared to that of developed markets. One factor contributing to the high volatility of returns in emerging markets is a lack of informational efficiency in the markets. The objective of this thesis is to examine the informational efficiency of the Indonesia Stock Exchange (IDX) by looking at the impact of the arrival of public information on the volatility of returns and investigating the relationship between trading volume, which is used as a proxy for the arrival of information, and volatility. Scheduled U.S. and Indonesian macroeconomic announcements are used as indicators for the arrival of public information. High-frequency data and an autoregressive econometric models are employed to examine the extent to which the volatility is affected by the macroeconomic announcements. Contrary to the literature, this thesis has found that, while most domestic macroeconomic announcements impact significantly on the volatility, there is no evidence that the U.S. Federal Open Market Committee announcements have an impact on volatility. In addition, the 2008 Global Financial Crisis significantly influenced the impact of macroeconomic news on the volatility of Indonesian equity market returns. This study also examines the relationship between market-wide realized volatility and trading volume of the Indonesian equity market. Trading volume has been used to indicate the arrival of new information, and its use as a proxy for information can improve understanding of the IDX’s microstructure. Consistent with the literature, this thesis reports different patterns of trading volume and returns volatility of the IDX during intraday trading. Using the Granger-causality test model, the study finds mixed results on the significance and direction of volume-volatility relationships. There are no Granger-causality relations between trading volume and volatility of returns of the Indonesian equity market during the full sample period. However, there is evidence of bi-directional causality relationships when observations are decomposed into subsample periods and days of the week. II DECLARATION I, Haryadi, declare that the DBA thesis entitled ‘Volatility of Returns, Trading Volume, and the Impact of Macroeconomic Announcements: High-frequency Evidence from the Indonesian Stock Market’ is no more than 65,000 words in length including quotes and exclusive of tables, figures, appendices, bibliography, references and footnotes. This thesis contains no material that has been submitted previously, in whole or in part, for the award of any other academic degree or diploma. Except where otherwise indicated, this thesis is my own work. Haryadi November 8, 2016 III TABLE OF CONTENTS ABSTRACT ................................................................................................................ II DECLARATION ........................................................................................................ III TABLE OF CONTENTS ............................................................................................ IV LIST OF FIGURES ................................................................................................. VIII LIST OF TABLES ...................................................................................................... IX ABBREVATIONS ....................................................................................................... X ACKNOWLEDGEMENTS ....................................................................................... XII CHAPTER 1 ................................................................................................................. 1 INTRODUCTION ........................................................................................................ 1 1.1 Background and motivation ................................................................................. 1 1.2 Research aims and questions ............................................................................... 4 1.3 Conceptual framework ......................................................................................... 5 1.4 Contribution to knowledge ................................................................................... 6 1.5 Statement of significance (practical contribution) ................................................ 6 1.6 Structure of the thesis .......................................................................................... 7 CHAPTER 2 ................................................................................................................. 9 THE INDONESIAN CAPITAL MARKET: AN OVERVIEW ...................................... 9 2.1 Introduction ......................................................................................................... 9 2.2 The Indonesian stock market: History and development ....................................... 9 2.2.1 Deregulation of Indonesian financial sector ................................................. 11 2.2.2 Indonesian stock market and two financial crises......................................... 14 2.3 Macroeconomic policy and financial markets stability ....................................... 18 2.3.1 Indonesian key macroeconomic indicators .................................................. 18 2.3.2 Indonesian macroeconomic policy ............................................................... 20 2.4 The structure of Indonesian financial markets .................................................... 21 2.4.1 The Indonesian stock market microstructure ................................................ 23 IV 2.4.2 The Indonesian stock market’s performance: Key statistics ......................... 27 2.5 Conclusion ........................................................................................................ 30 CHAPTER 3 ............................................................................................................... 31 VOLATILITY OF RETURNS, TRADING VOLUME AND THE IMPACT OF MACROECONOMIC ANNOUNCEMENTS: A REVIEW OF THE LITERATURE . 31 3.1 Introduction ....................................................................................................... 31 3.2 The volatility of returns: Theory and evidence ................................................... 31 3.2.1 Definition of volatility ................................................................................. 32 3.2.2 The importance of volatility ........................................................................ 33 3.2.3 The volatility of emerging stock market returns ........................................... 34 3.3 High-frequency data and intraday volatility of returns ....................................... 38 3.3.1 High-frequency data in finance studies ........................................................ 38 3.3.2 Types of volatility estimation ...................................................................... 39 3.3.3 Patterns of intraday volatility of returns ....................................................... 41 3.3.4 Intraday volatility and market microstructure noise ..................................... 43 3.4 Macroeconomic announcements, volatility of returns, and trading volume ........ 44 3.4.1 Theory of efficient markets ......................................................................... 44 3.4.2 Theory of market microstructure ................................................................. 46 3.5 The Global Financial Crisis and macroeconomic policy initiatives .................... 51 3.6 The gap in the literature .................................................................................... 53 3.7 Conclusion ........................................................................................................ 53 CHAPTER 4 ............................................................................................................... 55 DATA AND VARIABLES ......................................................................................... 55 4.1 Introduction ....................................................................................................... 55 4.2 Data and sample ................................................................................................ 55 4.2.1 Types and sources of data ............................................................................ 55 4.2.2 Sample period, asset prices and sampling frequency .................................... 56 4.3 Definition and measurement of variables ........................................................... 59 4.3.1 Intraday returns of LQ 45 index .................................................................. 59 4.3.2 Volatility of LQ45 index returns.................................................................. 60 V 4.3.3 Trading volume ........................................................................................... 64 4.4 Data of scheduled macroeconomic announcements ............................................ 67 4.4.1 The U.S. macroeconomic announcements ................................................... 67 4.4.2 Indonesian macroeconomic announcements ................................................ 69 4.4.3 The surprise component of scheduled macroeconomic announcements ....... 71 4.4.4 The time stamps of Indonesian macroeconomic announcements .................. 72 4.5 Conclusion ........................................................................................................ 74 CHAPTER 5 ............................................................................................................... 75 VOLATILITY OF RETURNS AND THE IMPACT OF MACROECONOMIC ANNOUNCEMENTS ................................................................................................. 75 5.1 Introduction ....................................................................................................... 75 5.2 The volatility of returns...................................................................................... 75 5.2.1 Descriptive statistics .................................................................................... 75 5.2.2 The time-series patterns of LQ45 price, returns and volatility ...................... 77 5.2.3 The intraday patterns of volatility of returns ................................................ 78 5.3 The impact of macroeconomic announcements on volatility ............................... 81 5.3.1 Methodology ............................................................................................... 81 5.3.2 Empirical findings ....................................................................................... 83 5.3.2.1 The stationarity and autocorrelation tests of the volatility series ............... 83 5.3.2.2 The impact of macroeconomic announcements and news ......................... 84 5.3.2.3 The impacts of the 2008 Global Financial Crisis ....................................... 90 5.4 Conclusion ........................................................................................................ 93 CHAPTER 6 ............................................................................................................... 94 TRADING VOLUME AND THE VOLATILITY OF RETURNS .............................. 94 6.1 Introduction ....................................................................................................... 94 6.2 Trading volume and volatility of returns relations ............................................. 94 6.2.1 Descriptive statistics .................................................................................... 94 6.2.2 The intraday patterns of trading volume and volatility ................................. 96 6.2.3 Correlation test of trading volume and volatility ........................................ 101 VI 6.3 The relationships between trading volume and volatility: Models and empirical findings ................................................................................................................. 102 6.3.1 Contemporaneous relationships between trading volume and volatility ..... 102 6.3.2 Causal relationships between trading volume and realized volatility .......... 104 6.4 Conclusion ...................................................................................................... 110 CHAPTER 7 ............................................................................................................. 112 CONCLUSION ........................................................................................................ 112 7.1 Introduction ..................................................................................................... 112 7.2 Summary of results and discussion................................................................... 113 7.3 Implications and recommendation ................................................................... 114 7.4 Limitations ...................................................................................................... 117 7.5 Suggestions for further research ...................................................................... 117 APPENDICES .......................................................................................................... 119 REFERENCES ......................................................................................................... 122 VII LIST OF FIGURES Figure 1.1 Conceptual framework ................................................................................. 5 Figure 2.1 Total stocks, bonds, rights and investment funds from 1977 to 1995 .......... 13 Figure 2.2 The number of securities and funds issuance before and after the 1998 crisis ................................................................................................................................... 16 Figure 2.3 Bank Indonesia’s policy transmission mechanism ...................................... 20 Figure 2.4 The Indonesia Stock Exchange: Trading mechanism .................................. 26 Figure 2.5 The Indonesian Stock Composite Index and Capital Market Milestones ..... 28 Figure 4.1 Thirty minute rolling window volatility ...................................................... 64 Figure 5.1 Time-series of the LQ45 price, returns and volatility, 2006 to 2012 ............ 78 Figure 5.2 The patterns of Intraday volatility full sample and subsample periods ........ 79 Figure 5.3 The patterns of intraday volatility by months of the year: ........................... 80 Figure 5.4 The patterns of intraday volatility by days of the week: Before, during, and after the GFC .............................................................................................................. 81 Figure 6.1 Intraday patterns of 30 minute window trading volume and volatility ......... 97 Figure 6.2 Intraday patterns of 30 minute window trading volume and volatility by subsample periods ....................................................................................................... 98 Figure 6.3 Intraday patterns of 30 minute window trading volume and volatility by months of the year....................................................................................................... 99 Figure 6.4 Intraday patterns of 30 minute window trading volume and volatility by days of the week ............................................................................................................... 100 VIII LIST OF TABLES Table 2.1 The growth of demand deposits and the number of bank offices .................. 12 Table 2.2 Components of Indonesian GDP Growth 2012–2013 ................................... 19 Table 2.3 The market capitalization of the Indonesia Stock Exchange and the stock exchanges of selected Asian countries ......................................................................... 22 Table 2.4 Trading hours of the stock exchanges in selected Asian countries ................ 24 Table 2.5 Trading schedule of the Indonesia Stock Exchange ...................................... 25 Table 2.6 Price increments between orders 2006 – 2014 ............................................. 27 Table 2.7 Auto Rejection System Levels ..................................................................... 27 Table 2.8 Key Market Indicators of the Indonesia Stock Exchange 2006 – 2014 ......... 29 Table 4.1 Description of market variables .................................................................. 59 Table 4.2 Number of observations of market variables ................................................ 66 Table 4.3 Scheduled macroeconomic announcements ................................................. 71 Table 4.4 Summary of the U.S. and Indonesian macroeconomic announcements & news ................................................................................................................................... 73 Table 5.1 Descriptive statistics of 30 minute realized volatility of the LQ45 index ...... 76 Table 5.2 Macroeconomic announcements and expected direction .............................. 84 Table 5.3 Regression results of the impact of macroeconomic announcements and news during the full sample period ....................................................................................... 85 Table 5.4 Regression results of the impact of macroeconomic announcements and news during the full sample period by days of the week ....................................................... 87 Table 5.5 Regression results of the impact of macroeconomic announcements and surprises during the full sample and around the GFC periods (Monday to Thursday) .. 92 Table 6.1 Descriptive statistics of trading volume & realized volatility of LQ45 index 95 Table 6.2 Correlation matrix of trading volume and volatility ................................... 101 Table 6.3 Results of the contemporaneous impact of trading volume on volatility ..... 103 Table 6.4 Tests for unit-roots for realized volatility and trading volume .................... 106 Table 6.5 Results of the VAR estimation and Granger-causality test ......................... 108 IX ABBREVATIONS ADF Augmented Dickey-Fuller AFC Asian Financial Crisis AOI All Ordinary Index ARC Advanced Release Calendar ARCH Autoregressive Conditional Heteroscedasticity ASIC Australian Securities and Investments Commission ASX Australian Securities Exchange Bapepam Badan Pengawas Pasar Modal (Indonesian Capital Market Supervisory Agency) BapepamLK Badan Pengawas Pasar Modal dan Lembaga Keuangan (Indonesian Capital Market and Financial Institutions Supervisory Agency) BEI Bursa Efek Indonesia (Indonesia Stock Exchange) BI Bank Indonesia BI Rate Bank Indonesia Target Interest Rate BPS Badan Pusat Statistik (Statistics Indonesia) CAR Capital Adequacy Ratio CBOE Chicago Board Options Exchange CCI Consumer Confidence Index CPI Consumer Price Index C-BEST Central Depository & Book Entry Settlement EMH Efficient Market Hypothesis FOMC The Federal Open Market Committee FKSSK Forum Koordinasi Stabilitas Sistem Keuangan (Financial System Stability Coordination Forum) GARCH Generalized Autoregressive Conditional Heteroscedasticity GDP Gross Domestic Product GFC Global Financial Crisis X