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Financial Integration: A New Methodology And An Illustration

Author

Listed:
  • Robert P. Flood

    (International Monetary Fund,)

  • Andrew K. Rose

    (University of California, Berkeley,)

Abstract

This paper develops a simple methodology to test for asset integration, and applies it within and between American stock markets. Our technique 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 must be equal across (risk-adjusted) assets in well-integrated markets. Assets are allowed to have standard risk characteristics, and are constrained by the Fama and French factor model of covariances over short time periods. We find that internal integration in the S&P 500 market is never rejected and is not generally rejected in the NASDAQ. Integration between the NASDAQ and the S&p, however, is always rejected dramatically. (JEL: G14) Copyright (c) 2005 by the European Economic Association.

Suggested Citation

  • 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:tpr:jeurec:v:3:y:2005:i:6:p:1349-1359
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    Citations

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    Cited by:

    1. Eduardo Levy Yeyati & Sergio Luis Schmukler & Neeltje Van Horen, 2006. "International Financial Integration through the Law of One Price," Business School Working Papers 2006-01, Universidad Torcuato Di Tella.
    2. 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, vol. 26(2), pages 137-163.
    3. Ying Xu & Jennifer Corbett, 2019. "Using Network Method to Measure Financial Interconnection," NBER Working Papers 26499, National Bureau of Economic Research, Inc.
    4. Arribas, Iván & Peiró-Palomino, Jesús & Tortosa-Ausina, Emili, 2020. "Is full banking integration desirable?," Journal of Banking & Finance, Elsevier, vol. 112(C).
    5. Xu, Ying & Corbett, Jenny, 2020. "What a network measure can tell us about financial interconnectedness and output volatility," Journal of the Japanese and International Economies, Elsevier, vol. 58(C).
    6. Flood, Robert P & Rose, Andrew, 2004. "Estimating the Expected Marginal Rate of Substitution: Exploiting Idiosyncratic Risk," CEPR Discussion Papers 4684, C.E.P.R. Discussion Papers.
    7. P N Smith & S Sorensen & M R Wickens, "undated". "An Asset Market Integration Test Based on Observable Macroeconomic Stochastic Discount Factors," Discussion Papers 03/14, Department of Economics, University of York.
    8. Claeys, Peter & Moreno, Rosina & Suriñach, Jordi, 2012. "Debt, interest rates, and integration of financial markets," Economic Modelling, Elsevier, vol. 29(1), pages 48-59.
    9. Arribas Fernández Iván & Pérez García Francisco & Tortosa-Ausina Emili, 2009. "Openness and Geographic Neutrality: How Do They Contribute to International Banking Integration?," Working Papers 201060, Fundacion BBVA / BBVA Foundation.
    10. Arribas, Iván & Pérez, Francisco & Tortosa-Ausina, Emili, 2011. "A network perspective on international banking integration," Journal of Policy Modeling, Elsevier, vol. 33(6), pages 831-851.
    11. De Santis, Roberto A. & Sarno, Lucio, 2008. "Assessing the benefits of international portfolio diversification in bonds and stocks," Working Paper Series 883, European Central Bank.
    12. Jennifer Corbett, 2010. "Asian Financial Integration," Chapters, in: Noel Gaston & Ahmed M. Khalid (ed.), Globalization and Economic Integration, chapter 5, Edward Elgar Publishing.
    13. Yarovaya, Larisa & Brzeszczyński, Janusz & Goodell, John W. & Lucey, Brian & Lau, Chi Keung Marco, 2022. "Rethinking financial contagion: Information transmission mechanism during the COVID-19 pandemic," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 79(C).
    14. Evans, Martin D.D. & Hnatkovska, Viktoria V., 2014. "International capital flows, returns and world financial integration," Journal of International Economics, Elsevier, vol. 92(1), pages 14-33.
    15. 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, vol. 22(2), pages 1-17, May.
    16. Mr. Phurichai Rungcharoenkitkul, 2011. "Risk Sharing and Financial Contagion in Asia: An Asset Price Perspective," IMF Working Papers 2011/242, International Monetary Fund.

    More about this item

    JEL classification:

    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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