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Limits to International Arbitrage: an Empirical Evaluation

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Hans Dewachter
Kristien Smedts

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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. 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. [Downloadable!] (restricted)
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  2. Shleifer, Andrei & Vishny, Robert W, 1997. " The Limits of Arbitrage," Journal of Finance, American Finance Association, vol. 52(1), pages 35-55, March. [Downloadable!] (restricted)
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  3. Madhavan, Ananth, 2000. "Market microstructure: A survey," Journal of Financial Markets, Elsevier, vol. 3(3), pages 205-258, August. [Downloadable!] (restricted)
  4. 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. [Downloadable!] (restricted)
  5. Keim, Donald B & Madhaven, Ananth, 1996. "The Upstairs Market for Large-Block Transactions: Analysis and Measurement of Price Effects," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 9(1), pages 1-36. [Downloadable!] (restricted)
  6. Chen, Zhiwu & Knez, Peter J, 1995. "Measurement of Market Integration and Arbitrage," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 8(2), pages 287-325. [Downloadable!] (restricted)
  7. 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, Oxford University Press for Society for Financial Studies, vol. 8(3), pages 879-918. [Downloadable!] (restricted)
  8. 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. [Downloadable!]
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  9. 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. [Downloadable!] (restricted)
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  10. 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. [Downloadable!] (restricted)
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