A new model-based approach to measuring time-varying financial market integration
AbstractWe investigate financial market integration by looking at the stock market linkages of five developed countries (France, Germany, Japan, the UK, and the US) over the period 1970:1- 2010:8. We measure the time-varying degree of world stock market integration of each country through the conditional variance of the country-specific premium in equity excess returns. The country-specific premiums are derived theoretically from an international CAPM with market imperfections. They are estimated from the latent factor decomposition implied by the theory through the use of state space methods that allow for GARCH errors. Our empirical results suggest that stock market integration has increased over the period 1970:1-2010:8 in all countries but Japan. And while there is a structural increase in stock market integration in four out of five countries, all countries also exhibit several shorter periods of disintegration (reversals), i.e. periods in which country-specific shocks play a more dominant role. Hence, stock market integration is measured as a dynamic process that is fluctuating in the short run while gradually increasing in the long run.
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Bibliographic InfoPaper provided by Ghent University, Faculty of Economics and Business Administration in its series Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium with number 11/714.
Length: 31 pages
Date of creation: Apr 2011
Date of revision:
financial markets; integration; factor model; unobserved component; GARCH;
Find related papers by JEL classification:
- G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
- C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-05-14 (All new papers)
- NEP-FMK-2011-05-14 (Financial Markets)
- NEP-IFN-2011-05-14 (International Finance)
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