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International financial integration through the law of one price

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  • Levy Yeyati, Eduardo
  • Schmukler, Sergio L.
  • Van Horen, Neeltje

Abstract

The authors argue that the cross-market premium (the ratio between the domestic and the international market price of cross-listed stocks) provides a valuable measure of international financial integration, reflecting accurately the factors that segment markets and inhibit price arbitrage. Applying to equity markets recent methodological developments in the purchasing power parity literature, they show that nonlinear Threshold Autoregressive (TAR) models properly capture the behavior of the cross market premium. The estimates reveal the presence of narrow non-arbitrage bands and indicate that price differences outside these bands are rapidly arbitraged away, much faster than what has been documented for good markets. Moreover, the authors find that financial integration increases with market liquidity. Capital controls, when binding, contribute to segment financial markets by widening the non-arbitrage bands and making price disparities more persistent. Crisis episodes are associated withhigher volatility, rather than by more persistent deviations from the law of one price.

Suggested Citation

  • 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.
  • Handle: RePEc:wbk:wbrwps:3897
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    References listed on IDEAS

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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. En defensa de los controles de capital
      by Eduardo Levy-Yeyati in Foco Económico on 2010-12-15 18:00:00

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    Cited by:

    1. Eduardo Levy-Yeyati & Sergio L. Schmukler & Neeltje van Horen, 2010. "Crises, Capital Controls and Financial Integration," Chapters, in: Masahiro Kawai & Mario B. Lamberte (ed.), Managing Capital Flows, chapter 6, Edward Elgar Publishing.
    2. Claessens, Stijn & Schmukler, Sergio L., 2007. "International financial integration through equity markets: Which firms from which countries go global?," Journal of International Money and Finance, Elsevier, vol. 26(5), pages 788-813, September.
    3. De la Torre, Augusto & Schmukler, Sergio, 2007. "Emerging Capital Markets and Globalization: The Latin American Experience," IDB Publications (Books), Inter-American Development Bank, number 349, May.
    4. Hutchison, Michael & Kendall, Jake & Pasricha, Gurnain & Singh, Nirvikar, 2009. "Indian capital control liberalization: Evidence from NDF markets," Working Papers 09/60, National Institute of Public Finance and Policy.
    5. Eduardo Levy Yeyati & Tomas Williams, 2014. "Financial Globalization in Emerging Economies: Much Ado About Nothing?," Economía Journal, The Latin American and Caribbean Economic Association - LACEA, vol. 0(Spring 20), pages 91-131, January.
    6. Douglas W. Arner & Paul Lejot & Wei Wang, 2010. "Governance and Financial Integration in East Asia," Chapters, in: Masahiro Kawai & Jong-Wha Lee & Peter A. Petri & Giovanni Capanelli (ed.), Asian Regionalism in the World Economy, chapter 6, Edward Elgar Publishing.
    7. Jinzhao Chen, 2012. "Crisis, Capital Controls and Covered Interest Parity: Evidence from China in Transformation," PSE Working Papers halshs-00660654, HAL.
    8. Levy Yeyati, Eduardo & Schmukler, Sergio L. & Van Horen, Neeltje, 2009. "International financial integration through the law of one price: The role of liquidity and capital controls," Journal of Financial Intermediation, Elsevier, vol. 18(3), pages 432-463, July.
    9. Goohoon Kwon & Mr. Raphael A Espinoza, 2009. "Regional Financial Integration in the Caribbean: Evidence From Financial and Macroeconomic Data," IMF Working Papers 2009/139, International Monetary Fund.
    10. 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.
    11. Patnaik, Ila & Shah, Ajay, 2011. "Did the Indian capital controls work as a tool of macroeconomic policy?," Working Papers 11/87, National Institute of Public Finance and Policy.
    12. Espinoza, Raphael & Prasad, Ananthakrishnan & Williams, Oral, 2011. "Regional financial integration in the GCC," Emerging Markets Review, Elsevier, vol. 12(4), pages 354-370.
    13. Claessens, Stijn & Klingebiel, Daniela & Schmukler, Sergio L., 2006. "Stock market development and internationalization: Do economic fundamentals spur both similarly?," Journal of Empirical Finance, Elsevier, vol. 13(3), pages 316-350, June.
    14. Matthieu Stigler & Ajay Shah & Ila Patnaik, 2010. "Understanding the ADR premium under market segmentation," Finance Working Papers 21850, East Asian Bureau of Economic Research.
    15. Augusto de la Torre & Sergio L. Schmukler, 2007. "Emerging Capital Markets and Globalization : The Latin American Experience," World Bank Publications, The World Bank, number 7187, September.

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    More about this item

    Keywords

    Markets and Market Access; Economic Theory&Research; Access to Markets; Macroeconomic Management; Fiscal&Monetary Policy;
    All these keywords.

    JEL classification:

    • F30 - International Economics - - International Finance - - - General
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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