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International financial integration through the law of one price: The role of liquidity and capital controls

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  • Levy Yeyati, Eduardo
  • Schmukler, Sergio L.
  • Van Horen, Neeltje

Abstract

This paper takes advantage of the fact that some stocks trade both in domestic and international markets to characterize the degree of international financial integration. The paper argues that the cross-market premium (the ratio between the domestic and the international market price of cross-listed stocks) provides a valuable measure of international financial integration and the effectiveness of capital controls. Using autoregressive (AR) models to estimate convergence speeds and non-linear threshold autoregressive (TAR) models to identify non-arbitrage bands, the paper shows that price deviations across markets are rapidly arbitraged away and bands are narrow, particularly so for liquid stocks. The paper also shows that regulations on cross-border capital flows effectively segment domestic markets. As expected, the effects of both types of capital controls are asymmetric but in the opposite direction: controls on outflows induce positive premia, while controls on inflows generate negative premia. Both vary with the intensity of capital controls.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Financial Intermediation.

Volume (Year): 18 (2009)
Issue (Month): 3 (July)
Pages: 432-463

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Handle: RePEc:eee:jfinin:v:18:y:2009:i:3:p:432-463

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Web page: http://www.elsevier.com/locate/inca/622875

Related research

Keywords: Capital market integration Market segmentation AR TAR Law of one price;

References

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Citations

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Cited by:
  1. Juan Carlos Gozzi & Ross Levine & Maria Soledad Martinez Peria & Sergio L. Schmukler, 2012. "How Firms Use Domestic and International Corporate Bond Markets," NBER Working Papers 17763, National Bureau of Economic Research, Inc.
  2. Ma, Guonan & McCauley, Robert N., 2013. "Is China or India more financially open?," Journal of International Money and Finance, Elsevier, vol. 39(C), pages 6-27.
  3. Gurnain Kaur Pasricha, 2010. "Bank Competition and International Financial Integration: Evidence Using a New Index," Working Papers 10-35, Bank of Canada.
  4. Eichler, Stefan & Karmann, Alexander & Maltritz, Dominik, 2009. "The ADR shadow exchange rate as an early warning indicator for currency crises," Journal of Banking & Finance, Elsevier, vol. 33(11), pages 1983-1995, November.
  5. Karl Friedrich Habermeier & Annamaria Kokenyne & Chikako Baba, 2011. "The Effectiveness of Capital Controls and Prudential Policies in Managing Large Inflows," IMF Staff Discussion Notes 11/14, International Monetary Fund.
  6. Oxelheim, Lars & Randoy, Trond & Stonehill, Arthur, 2011. "What Can International Finance Add to International Strategy?," Working Paper Series 888, Research Institute of Industrial Economics.
  7. Stigler, Mathieu & Shah, Ajay & Patnaik, Ila, 2010. "Understanding the ADR premium under market segmentation," Working Papers 10/71, National Institute of Public Finance and Policy.
  8. Ila Patnaik & Ajay Shah, 2012. "Did the Indian Capital Controls Work as a Tool of Macroeconomic Policy?," IMF Economic Review, Palgrave Macmillan, vol. 60(3), pages 439-464, September.
  9. Jinzhao Chen, 2012. "Crisis, Capital Controls and Covered Interest Parity: Evidence from China in Transformation," PSE Working Papers halshs-00660654, HAL.

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