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Limits to International Arbitrage: an Empirical Evaluation

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  • Hans Dewachter
  • Kristien Smedts

Abstract

This paper studies international financial integration by testing the law of one price across national borders. We extend the methodology as proposed by Chen and Knez (1995) to an international environment and analyze the level of cross-border mispricings. The empirical analysis shows that pricing errors are relatively large. This lack of international financial integration is subsequently analyzed in the market micro-finance literature. We find that micro-factors explain a considerable part of the variance in cross-border pricing errors.

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Paper provided by Katholieke Universiteit Leuven, Centrum voor Economische Studiën in its series Center for Economic Studies - Discussion papers with number ces0401.

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Date of creation: Mar 2004
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Handle: RePEc:ete:ceswps:ces0401

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  1. Andrei Shleifer & Robert W. Vishny, 1995. "The Limits of Arbitrage," NBER Working Papers 5167, National Bureau of Economic Research, Inc.
  2. Gikas A. Hardouvelis & Rafael La Porta & Thierry A. Wizman, 1993. "What moves the discount on country equity funds?," Research Paper 9324, Federal Reserve Bank of New York.
  3. Brandt, Michael W. & Santa-Clara, Pedro, 2002. "Simulated likelihood estimation of diffusions with an application to exchange rate dynamics in incomplete markets," Journal of Financial Economics, Elsevier, vol. 63(2), pages 161-210, February.
  4. Owen A. Lamont & Richard H. Thaler, 2001. "Can the Market Add and Subtract? Mispricing in Tech Stock Carve-Outs," NBER Working Papers 8302, National Bureau of Economic Research, Inc.
  5. Ivo Welch, 2000. "Views of Financial Economists on the Equity Premium and on Professional Controversies," Yale School of Management Working Papers ysm122, Yale School of Management.
  6. Froot, Kenneth A. & Dabora, Emil M., 1999. "How are stock prices affected by the location of trade?," Journal of Financial Economics, Elsevier, vol. 53(2), pages 189-216, August.
  7. Hansen, Lars Peter & Jagannathan, Ravi, 1997. " Assessing Specification Errors in Stochastic Discount Factor Models," Journal of Finance, American Finance Association, vol. 52(2), pages 557-90, June.
  8. S. Baranzoni & P. Bianchi & L. Lambertini, 2000. "Market Structure," Working Papers 368, Dipartimento Scienze Economiche, Universita' di Bologna.
  9. David K. Backus, 2001. "Affine Term Structure Models and the Forward Premium Anomaly," Journal of Finance, American Finance Association, vol. 56(1), pages 279-304, 02.
  10. Bodurtha, James N, Jr & Kim, Dong-Soon & Lee, Charles M C, 1995. "Closed-End Country Funds and U.S. Market Sentiment," Review of Financial Studies, Society for Financial Studies, vol. 8(3), pages 879-918.
  11. Keim, Donald B & Madhaven, Ananth, 1996. "The Upstairs Market for Large-Block Transactions: Analysis and Measurement of Price Effects," Review of Financial Studies, Society for Financial Studies, vol. 9(1), pages 1-36.
  12. Madhavan, Ananth, 2000. "Market microstructure: A survey," Journal of Financial Markets, Elsevier, vol. 3(3), pages 205-258, August.
  13. Chen, Zhiwu & Knez, Peter J, 1995. "Measurement of Market Integration and Arbitrage," Review of Financial Studies, Society for Financial Studies, vol. 8(2), pages 287-325.
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