Assessing Monetary Credibility of ASEAN Countries: A Time-Varying Analysis with CAPM and Kalman Filter Algorithm

Abstract

The focus of this study is to assess the monetary credibility of ASEAN countries in relation to three key anchors: China, Japan, and the USA. The analysis employs a time-varying credibility index, which is derived using the Capital Assets Price Model methodology. To estimate this index, the study utilizes the Kalman Filter Algorithm, a statistical technique commonly employed in econometrics for state estimation and time-series analysis. By applying the CAPM methodology within the framework of the Kalman Filter Algorithm, the study aims to provide insights into the evolving monetary credibility of ASEAN countries vis-à-vis their relationships with China, Japan, and the USA. The CAPM approach allows for the assessment of the risk-return relationship in financial markets, while the Kalman Filter Algorithm enables the tracking of time-varying parameters, making it well-suited for analyzing changing dynamics over time. In the context of multivariate Markov regime switching models, the credibility index is modeled to be dependent on macroeconomic fundamentals, with asymmetric effects observed across two distinct regimes. These models incorporate time-varying transition probabilities influenced by macro-fundamentals, facilitating the switching between high and low credibility regimes. Notably, the analysis reveals significant findings when comparing the credibility of ASEAN countries against the USA, China, and Japan. The results suggest that the USA emerges as a relatively favorable choice of anchor for APSCs in terms of monetary credibility. This conclusion is drawn from the observed dynamics within the MRS models, where the USA exhibits distinctive attributes that position it as a more suitable reference point compared to China and Japan. These findings underscore the importance of considering not only the absolute levels of credibility but also the relative performance of different anchor countries when assessing monetary dynamics within the APSCs.