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Financial Integration: A New Methodology and an Illustration

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  • Robert P. Flood
  • Andrew K. Rose

Abstract

This paper develops a simple new methodology to test for asset integration and applies it within and between American stock markets. Our technique is tightly based on a general intertemporal asset-pricing model, and relies on estimating and comparing expected risk-free rates across assets. Expected risk-free rates are allowed to vary freely over time, constrained only by the fact that they are equal across (risk-adjusted) assets. Assets are allowed to have general risk characteristics, and are constrained only by a factor model of covariances over short time periods. The technique is undemanding in terms of both data and estimation. We find that expected risk-free rates vary dramatically over time, unlike short interest rates. Further, the S&P 500 market seems to be well integrated, and the NASDAQ is generally (but not always) integrated. However, the NASDAQ is poorly integrated with the S&P 500.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9880.

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Date of creation: Aug 2003
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Publication status: published as Robert P. Flood & Andrew K. Rose, 2005. "Financial Integration: A New Methodology And An Illustration," Journal of the European Economic Association, MIT Press, vol. 3(6), pages 1349-1359, December.
Handle: RePEc:nbr:nberwo:9880

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  1. Hansen, Lars Peter & Jagannathan, Ravi, 1991. "Implications of Security Market Data for Models of Dynamic Economies," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 99(2), pages 225-62, April.
  2. Fama, Eugene F & French, Kenneth R, 1996. " Multifactor Explanations of Asset Pricing Anomalies," Journal of Finance, American Finance Association, American Finance Association, vol. 51(1), pages 55-84, March.
  3. Chen, Zhiwu & Knez, Peter J, 1995. "Measurement of Market Integration and Arbitrage," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 8(2), pages 287-325.
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Cited by:
  1. Evans, Martin D.D. & Hnatkovska, Viktoria V., 2014. "International capital flows, returns and world financial integration," Journal of International Economics, Elsevier, Elsevier, vol. 92(1), pages 14-33.
  2. Rose, Andrew-K, 2004. "Equity Integration in Japan: An Application of a New Method," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, Institute for Monetary and Economic Studies, Bank of Japan, vol. 22(2), pages 1-17, May.
  3. Arribas Fernández Iván & Pérez García Francisco & Tortosa-Ausina Emili, 2009. "Openness and Geographic Neutrality: How Do They Contribute to International Banking Integration?," Working Papers, Fundacion BBVA / BBVA Foundation 201060, Fundacion BBVA / BBVA Foundation.
  4. Arribas, Iván & Pérez, Francisco & Tortosa-Ausina, Emili, 2011. "A network perspective on international banking integration," Journal of Policy Modeling, Elsevier, Elsevier, vol. 33(6), pages 831-851.
  5. P N Smith & S Sorensen & M R Wickens, . "An Asset Market Integration Test Based on Observable Macroeconomic Stochastic Discount Factors," Discussion Papers, Department of Economics, University of York 03/14, Department of Economics, University of York.
  6. Levy Yeyati, Eduardo & Schmukler, Sergio L. & Van Horen, Neeltje, 2006. "International financial integration through the law of one price," Policy Research Working Paper Series 3897, The World Bank.
  7. Robert P. Flood & Andrew K. Rose, 2004. "Estimating the Expected Marginal Rate of Substitution: Exploiting Idiosyncratic Risk," NBER Working Papers 10805, National Bureau of Economic Research, Inc.
  8. De Santis, Roberto A. & Sarno, Lucio, 2008. "Assessing the benefits of international portfolio diversification in bonds and stocks," Working Paper Series, European Central Bank 0883, European Central Bank.
  9. Claus, Edda & Lucey, Brian M., 2012. "Equity market integration in the Asia Pacific region: Evidence from discount factors," Research in International Business and Finance, Elsevier, Elsevier, vol. 26(2), pages 137-163.
  10. Claeys, Peter & Moreno, Rosina & Suriñach, Jordi, 2012. "Debt, interest rates, and integration of financial markets," Economic Modelling, Elsevier, Elsevier, vol. 29(1), pages 48-59.

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