## 3. Convergence Speed vs. Foreign Liabilities

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---

### I. Introduction and scope
- Assessment focus: regional financial integration in the 15 CARICOM countries.
- Historical and size context:
  - CARICOM founded 1973 (Treaty of Chaguaramas). Original members: Barbados, Jamaica, Guyana, Trinidad and Tobago. Later entrants listed exactly in source.
  - Region population: 15 million inhabitants.
  - Region GDP: hovers around US$40 billion (2004).
- Economic heterogeneity highlights:
  - Micro-states (Antigua and Barbuda, Bahamas, Barbados, St Kitts and Nevis) have less than 300 thousand inhabitants and GDP per capita greater than US$10,000 in PPP.
  - Trinidad and Tobago overtook Jamaica in 2000 as the largest economy, with GDP exceeding US$12 billion (2005).
  - Five of the 10 largest regional financial institutions are based in Trinidad and Tobago.
- Rationale for regional financial integration (as given):
  - Efficiency in allocation of capital; competition raising savings and investment.
  - Risk-diversification and reduced profit/consumption volatility.
  - Regulatory transparency and market discipline.
  - Region-specific benefits: economies of scale in financial industry for small states; trade-credit links that strengthen financial links; benefits for countries considering or in currency unions from prior financial integration.
- Key introductory numeric and factual points:
  - Inward FDI represents more than two thirds of the financial account.
  - Market capitalization: above 100 percent for Trinidad and Tobago, Jamaica and Barbados.
  - Market capitalization growth: 544 percent for JSE between 1997 and 2003; 246 percent for TTSE.
  - Composite index increases: 240 percent increase for JSE between 1997 and 2003; 97 percent for TTSE.
  - Liquidity generally below 5 percent (TTSEC, 2004); comparison: average of 17 percent for cited Latin American countries; OECD commonly above 60 percent.
  - Regional exports: 9.5 percent of GDP in 2005.
  - Regional financial groups: hold assets worth on average 166 percent of regional GDP; 60 percent of those assets held by the 10 largest regional financial institutions.
  - Trinidad and Tobago banks: hold around 76 percent of their assets domestically, and 20 percent regionally.

### II. Measurement approach and background (interest rates, T-Bills)
- Measurement constraints:
  - BIS consolidated bank claims and IMF CPIS are poorly informative for CARICOM (CPIS available only for Bahamas and Barbados among CARICOM).
  - Use of indirect measures: price-based (interest rates, stock prices) and quantity-based (current account dynamics).
- Institutional milestones:
  - Central Bank of Trinidad and Tobago creation: 1964.
  - Eastern Caribbean Central Bank (ECCB) founded: 1983.
- Exchange rate regimes:
  - Five CARICOM countries with floating regimes: Guyana, Haiti, Jamaica, Suriname, Trinidad and Tobago (Suriname and Trinidad and Tobago heavily managed).
- T-Bill market and yields:
  - Near-absence of re-trading; yields often represent first-auction prices and are not volatile.
  - Jamaica and Guyana experienced prolonged high interest rates in the 1990s.
  - Principal Component Analysis: first component strongly linked to the U.S. interest rate; main economies (Jamaica, Trinidad and Tobago) follow their own stochastic processes; 2004 Jamaican exchange rate crisis had no effect on neighbors.
- UIP conversion and expectations:
  - Uncovered Interest Parity (UIP) yields converted into Trinidad and Tobago Dollar (TTD) equivalents using three expectation forms: rational (future 12 months), backward (past 12 months), mixed (6 months before to 6 months after current time).
  - Correlation coefficients between Trinidad and Tobago rate and regional bond yields: average correlation around 0.2 (for all expectation specifications).
  - Correlation between U.S. and Trinidad and Tobago rates: 0.9.
- Sigma-convergence:
  - Sigma-convergence (cross-country standard deviation of interest rates declining) appears present since 1995, but driven by Jamaica and Guyana; sigma-convergence absent when those two excluded.

### III. Stock price convergence — data and AR findings
- Motivation for cross-listed stock analysis:
  - Cross-listed identical stocks traded in two markets remove aggregation bias; better measure of market integration.
  - CARICOM large companies frequently cross-list, mainly in TTSE, JSE, and BSE; 9 companies studied account for more than 50 percent of TTSE market capitalization.
- CARICOM cross-listing sample and filtering:
  - CARICOM sample: 9 firms generating 11 cross-premium series: 8 TTO-JAM series, 3 TTO-BRB series (note: 9 firms generated 11 series).
  - Kept series with more than 100 trading days; excluded days without positive trading volume in both markets.
  - Average number of week days between two simultaneous trading days in CARICOM sample: 5.4.
- Cross-market premium definition (preserved exactly):
  - p_t = 100 * (S1_t / ER1_t - S2_t / ER2_t) / (S2_t / ER2_t)
- Observed premium magnitudes:
  - Premiums for CARICOM cross-listed stocks are greater than 3 percent and comparable to illiquid emerging-market stocks in Levy Yeyati et al. (2006).
- AR estimation strategy and diagnostics:
  - AR regressions on the premium with GARCH(1,1) corrections (mean equation includes three lags; variance equation includes ARCH(1) α1 and GARCH(1) λ1).
  - Quasi-Maximum Likelihood Estimator used.
  - All beta-coefficients have expected (negative) sign; all but two coefficients are highly significant.
- AR half-life results (simultaneous trading day unit):
  - Average half-life for TTO-JAM premium: 18 week days.
  - TTO-JAM half-life is 9 times higher than France–Germany or Argentina–Brazil cross-listings, and more than twice larger than Singapore–Hong-Kong estimate.
  - BRB-TTO half-life larger than TTO-JAM due to very low liquidity in BSE.
  - When measured in simultaneous trading days, Caribbean half-lives are shorter than between Singapore and Hong-Kong and of the same order of magnitude as Argentina–Brazil.
- Liquidity vs. arbitrage interpretation:
  - No major structural barriers to arbitrage within the Caribbean once traded, but illiquidity substantially hampers market functioning and financial integration.
- Third-market effect caveat:
  - Some Caribbean stocks (GKC and GHL) are cross-listed in advanced markets; such listings could facilitate price discovery and bias intra-regional convergence measures.

### IV. Non-linear dynamics: TAR–GARCH findings and robustness
- TAR model approach:
  - Band-TAR–GARCH separates “small” (in-band) and “large” (out-of-band) arbitrage opportunities; estimates β_in, β_out and endogenous threshold c.
  - Threshold selection: c ∈ [p_10th ; p_90th], incremented by steps of 0.1; chosen by maximum likelihood.
- Key TAR numerical findings and diagnostics:
  - Optimal threshold (TTO-JAM premium): average c = 8.1.
  - β_out coefficients are negative; in most cases β_in is also negative and |β_in| < |β_out|.
  - TAR half-lives out of the neutral band: average around 7.3 week days for TTO-JAM premium.
  - Half-life benchmark: around 5 days for Hong-Kong and Singapore cross-listings.
- Robustness checks and alternative estimators:
  - Forcing β_in = 0 (Levy Yeyati et al. (2006)) yields on average c = 8.35, β_out = -0.56 for the TTO-JAM premiums.
  - Obstfeld-Taylor (1997) two-equation estimator gives on average c = 6.4, β_out = -0.57.
  - On de-trended data: neutral bands remain high (around 5) while β_out becomes smaller (around -0.2).
- Appendix A selected (G)ARCH–TAR excerpts (preserved exactly):
  - TTO-JAM premium (out band): c (out band): 8.1; Week: -0.1; days: -0.43; half-life 1: 31.43; half-life 2: 37.26.
  - GKC: c 6.5; Week: -0.2 ***; days: -0.35 ***; half-life 1: 1.58; half-life 2: 5.24.
  - JMMB: c 14.3; Week: -0.1 **; days: -0.64 ***; half-life 1: 0.67; half-life 2: 1.59.
  - RBTT (no GARCH): c 4.2; Week: -0.4 *; days: -0.39 ***; half-life 1: 1.39; half-life 2: 12.84.
  - FCIB (no GARCH): c 7.3; Week: -0.4; days: -0.49 ***; half-life 1: 1.03; half-life 2: 8.03.
  - NCBJ: c 2.2; Week: 0.7; days: -0.23 ***; half-life 1: 2.69; half-life 2: 5.69.
  - CCMB: c 11.4; Week: -0.2 ***; days: -0.28 **; half-life 1: 2.07; half-life 2: 5.59.
  - DBG: c 4.9; Week: 0.46 ***; days: -0.66 ***; half-life 1: 0.64; half-life 2: 1.78.
  - GHL: c 14.1; Week: -0.4 ***; days: -0.41 ***; half-life 1: 1.33; half-life 2: 17.35.
  - Note: significance markers (*, **, ***) and "n.a." entries preserved exactly as in source.

### V. Quantity evidence: current account convergence and regional trade dynamics
- Theoretical frame:
  - Trehan and Walsh (1991): stationarity of ca_t (current account as share of GDP) is sufficient for long-run no-Ponzi condition; speed of adjustment of the current account is a measure of financial integration (Taylor, 2002).
- Panel estimation specification:
  - ∆ca_it = α_i + β_i ca_it-1 + ε_it
- Regional groups pooled (exact groups):
  - i) CARICOM14 (all CARICOM countries but Montserrat)
  - ii) EU15 (Belgium and Luxembourg merged)
  - iii) MERCOSUR+5 (10 South American countries)
  - iv) ASEAN10+3 (13 countries participating in the Chiang Mai Initiative)
  - v) ECOWAS15 (members except Liberia)
- Estimators used:
  - Mean Group Estimator (MGE)
  - Fixed Effects (FE) / Pooled OLS (POLS) / Random Effects (RE) as appropriate
  - Levin, Lin and Chu (LLC, 2002)
  - Arellano and Bond GMM
- Main estimation results and key statistics:
  - All estimators confirm negative beta for all periods and regions.
  - CARICOM beta: -0.4 (close to the world average).
  - Levin-Lin-Chu test confirms stationarity of the current account at the 1 percent level for all regions.
  - Correlation between beta-coefficient and log of volume of foreign liabilities (percent of GDP, 1975-2005 average): 0.35 for all countries, 0.66 after removing the 5 most obvious outliers.
  - Fixed-effects regression with CARICOM dummy: β_i^C significantly positive in baseline but not robust to heteroscedasticity adjustments.
- Sub-period analysis (1975–90 and 1991–2005):
  - Larger speed of adjustment (more negative beta) in 1975–90 across regions.
  - Except LLC estimator, CARICOM14 appears least integrated until the 1990s.
  - Post-1990: CARICOM14 has become more integrated; levels above other LDCs but below EU15 and ASEAN+3.
- Regional trade balance dynamics:
  - Exports to CARICOM partners: approaching 10 percent GDP (recent years).
  - Regional trade imbalances account for more than 40 percent of current account deficits for most CARICOM countries.
  - Panel for regional trade balance: ∆ca*_it = α_i + β_i* ca*_it-1 + ε_it with MGE average β = -0.34.
- Extended model controlling for extra-regional current account ca' = ca − ca*:
  - Specification used: ∆ca*_it = α_i + β_i* ca*_it-1 + γ_i ∆ca'_it + δ_i ca'_it-1 + ε_it
  - Interpretation of γ_i:
    - γ_i < 0: extra-regional current account adjusts when regional trade balance is in deficit.
    - γ_i = -1: symmetric adjustment between ca' and ca*.
    - γ_i ≈ 0: indicates low world financial integration.
  - Example estimates and interpretation:
    - MERCOSUR+5: γ estimate is 0 (lack of integration to world markets).
    - ASEAN+3: highly integrated to world markets (γ large in magnitude).
    - CARICOM14: intermediate—less integrated than developed countries but better than MERCOSUR+5 and ECOWAS15.
  - Estimator sensitivity: MGE favored for heterogeneity; FE and Arellano-Bond produce differing rankings in some cases.

### VI. Cross-cutting empirical findings and key statistics (enumerated)
- TAR and price-convergence numbers:
  - Optimal threshold (TTO-JAM premium): average 8.1.
  - Half-life out-of-band (TTO-JAM): around 7.3 week days.
  - Half-life benchmark for Hong-Kong and Singapore cross-listings: around 5 days.
  - Forced β_in = 0 results: c = 8.35, β_out = -0.56 (TTO-JAM on average).
  - Obstfeld-Taylor two-equation estimator: c = 6.4, β_out = -0.57.
  - De-trended data: neutral bands ~5, β_out ≈ -0.2.
- Current account / integration statistics:
  - CARICOM beta: -0.4.
  - MGE average β for regional trade balance: -0.34.
  - Correlation between beta and log foreign liabilities: 0.35 (all countries), 0.66 (after removing 5 outliers).
  - Exports to CARICOM partners: approaching 10 percent GDP.
  - Regional trade imbalances contribution: more than 40 percent of current account deficits for most CARICOM countries.
- Sample and periods:
  - Main sub-periods analyzed: 1975–90 and 1991–2005.
  - Regional groups used: CARICOM14, EU15, MERCOSUR+5, ASEAN10+3 (ASEAN13), ECOWAS15.

### VII. Policy-relevant conclusions and recommendations
- Primary conclusions:
  - Price-based evidence (AR and TAR) indicates slow price convergence in the Caribbean; half-lives exceed those in more integrated markets even after controlling for cross-listing frequency.
  - Macroeconomic (current account) evidence places CARICOM14 in the middle of studied regions: more integrated than some LDC groups but lagging EU15 and ASEAN+3.
  - Regional financial integration has improved in recent decades, but rankings are sensitive to estimator choice and sample period.
- Policy challenges identified:
  - Illiquidity and market functioning:
    - Re-trading is almost inexistent in bond markets and inefficient in stock markets despite large market capitalization and high debt levels.
    - Institutional barriers (e.g., inefficient settlement systems) likely impede market functioning.
  - Dependence on transient flow drivers:
    - Recent large regional flows were mostly driven by Trinidad and Tobago’s current account surpluses (oil-price related); these flows may vanish with low oil prices.
- Policy implications and priorities:
  - Strengthen market infrastructure and institutional frameworks to improve liquidity and efficiency in equity and debt markets (for example, settlement systems).
  - Design policies to sustain regional flows beyond commodity-driven surpluses to reduce vulnerability to commodity price cycles.
  - Continue monitoring and promoting both regional and global financial integration, with attention to country heterogeneity and estimator sensitivity.

*Source: _wp09139 — "3. Convergence Speed vs. Foreign Liabilities" and Appendix A (IMF staff working paper excerpt).*

### References..............................................................................................................

### _wp09139 - References..............................................................................................................

### Sections
- References................................................................................................................................19
- Appendix A ..............................................................................................................................22

### Tables
- 1.      Balance of Payments.......................................................................................................23
- 2.      UNCTAD FDI Inward Stock (In millions U.S. dollars, 2001 ........................................23
- 3.      UNCTAD FDI Outward Stock (In millions of U.S. dollars, 2001) ................................24
- 4.  Regional Exports, as a Share of GDP ............................................................................24
- 5.      Interest Rates: Principal Component Analysis, 1980m1–2005m12 ...............................24
- 6.      Interest Comovements ....................................................................................................25
- 7.      Cross-Listed Stocks ........................................................................................................25
- 8.      Cross-Market Premium ...................................................................................................26 
- 9.      (G) ARCH-AR Model.....................................................................................................27 
- 10.    (G) ARCH-TAR Model ..................................................................................................28 
- 11.  β Coefficient from 1975–2005........................................................................................28 
- 12.  β Coefficient from 1975–90............................................................................................29 
- 13.  β Coefficient from 1991–2005........................................................................................29
- 14.    Regional Financial Integration 1975–2005.....................................................................29 
- 15.    1975–90 Estimates of Regional Financial Integration....................................................30 
- 16.    1991–2005 Estimates of Regional Financial Integration................................................31 

### Figures
- 1.      Interest Rates in the CARICOM and Sigma-Convergence (3 month T-Bills) .............. 32
- 2.      Cross-Listed Stocks ....................................................................................................... 33

*Source: _wp09139 - References (PDF chapter/section).*

### 3.      Convergence Speed vs. Foreign Liabilities ................................................................... 35

### 3.      Convergence Speed vs. Foreign Liabilities

### I. Introduction
- Scope: assessment of regional financial integration in the 15 CARICOM countries.
- Historical and size context:
  - CARICOM founded by the Treaty of Chaguaramas in 1973; original members Barbados, Jamaica, Guyana, Trinidad and Tobago.
  - Later entrants: Antigua and Barbuda, Belize, Dominica, Grenada, Montserrat, Saint-Kitts and Nevis, Saint Lucia, Saint Vincent and the Grenadines (1974); Bahamas (1983); Suriname (1995); Haiti (1998).
  - Region population: 15 million inhabitants.
  - Region GDP: hovers around US$40 billion (2004).
- Economic heterogeneity:
  - Micro-states (Antigua and Barbuda, Bahamas, Barbados, St Kitts and Nevis) have less than 300 thousand inhabitants and benefit from a GDP per capita greater than US$10,000 in PPP.
  - Trinidad and Tobago overtook Jamaica in 2000 as the largest economy, with GDP exceeding US$12 billion (2005).
  - Trinidad and Tobago became the main exporter of capital and main financial center: 5 of the 10 largest regional financial institutions are based in Trinidad and Tobago.
- Rationale for regional financial integration (three traditional benefits plus three region-specific points):
  - Efficiency in allocation of capital, competition raising savings and investment.
  - Risk-diversification and reduced profit/consumption volatility.
  - Regulatory transparency and market discipline.
  - Region-specific: economies of scale in financial industry for many small states; trade-credit links strengthen financial links; benefits for countries considering or in currency unions from prior financial integration.

### Limitations and measurement approach
- Limitations of deeper integration:
  - Small diversification benefits if business cycles are synchronized.
  - Greater contagion risk among similar countries.
  - Potential mitigants: exchange rate cooperation, swap agreements, regional monetary funds.
- Measurement constraints:
  - Standard datasets (BIS consolidated bank claims, CPIS) poorly informative for CARICOM: BIS flows originate from developed/advanced emerging markets; CPIS available only for Bahamas and Barbados among CARICOM.
  - Lack of flow data forces indirect measures: price-based evidence (interest rates, stock prices) and quantity-based evidence (current account dynamics).
- Study design:
  - Section II: background on financial sector, financial accounts, and interest rate convergence.
  - Section III: stock price convergence using 9 cross-listed stocks (representing more than 50 percent of TTSE market capitalization), estimation via AR and TAR models to measure speed of arbitrage and non-linearities.
  - Section IV (summary mention): quantity evidence using dynamics of current account and regional trade imbalances, comparing to EU15, ASEAN+3, and other LDCs.

### Key introductory numeric and factual points
- Inward FDI represents more than two thirds of the financial account.
- Market capitalization measures:
  - Market capitalization above 100 percent for Trinidad and Tobago, Jamaica and Barbados.
  - Market capitalization growth: 544 percent for JSE between 1997 and 2003; 246 percent for TTSE.
  - Composite index increases: 240 percent increase for JSE between 1997 and 2003; 97 percent for TTSE.
- Liquidity:
  - Generally below 5 percent (TTSEC, 2004).
  - Comparison: average of 17 percent for cited Latin American countries.
  - OECD countries commonly enjoy liquidity ratios above 60 percent.
- Regional trade:
  - Regional exports reached 9.5 percent of GDP in 2005.
- Regional financial groups:
  - Hold assets worth on average 166 percent of regional GDP; 60 percent of those assets held by the 10 largest regional financial institutions.
- Trinidad and Tobago banks: hold around 76 percent of their assets domestically, and 20 percent regionally.

### II. Background (interest rates and T-Bills)
- Institutional milestones:
  - Central Bank of Trinidad and Tobago creation: 1964.
  - Eastern Caribbean Central Bank (ECCB) founded: 1983.
- Exchange rate regimes:
  - 5 CARICOM countries with floating regimes: Guyana, Haiti, Jamaica, Suriname, Trinidad and Tobago (Suriname and Trinidad and Tobago heavily managed).
- T-Bill market issues:
  - Near-absence of re-trading; yields often represent first-auction prices and are not volatile.
  - Jamaica and Guyana experienced prolonged high interest rates in the 1990s.
- Principal Component Analysis findings on yields:
  - First component strongly linked to the U.S. interest rate.
  - Main economies (Jamaica, Trinidad and Tobago) follow their own stochastic processes; 2004 Jamaican exchange rate crisis had no effect on neighbors.
- Uncovered Interest Parity (UIP) yields used to convert domestic yields into Trinidad and Tobago Dollar (TTD) equivalents; three expectation forms used: rational (future 12 months), backward (past 12 months), mixed (6 months before to 6 months after current time).
- Correlations and convergence:
  - Correlation coefficients between Trinidad and Tobago rate and regional bond yields: average correlation around 0.2 (for all expectation specifications).
  - Correlation between U.S. and Trinidad and Tobago rates: 0.9.
  - Sigma-convergence (cross-country standard deviation of interest rates declining) appears present since 1995, but driven by Jamaica and Guyana; sigma-convergence absent when those two excluded.

### III. Stock Price Convergence (motivation and approach)
- Rationale for cross-listed stock analysis:
  - Aggregate indices suffer aggregation bias; identical stock prices traded in two markets give a better measure of market integration.
  - CARICOM large companies frequently cross-list, mostly in TTSE, JSE, and BSE.
  - The 9 companies studied account for more than 50 percent of TTSE market capitalization.
- Prior literature:
  - Levy Yeyati et al. (2006): AR and TAR dynamics of cross-market premium; find low cross-country premium (0.16 percent) in their EM sample and show liquidity and capital account regulations affect premium behavior.
- Illiquidity characteristics and implications:
  - Illiquid assets: negative autocorrelation of returns; variance autocorrelation higher; movements of illiquid stocks lag liquid ones.
  - Evidence in CARICOM: several TTSE-traded cross-listings (GKC, JMMB, NCBJ, DBG, CCMB) lag their JSE counterparts.

### A. Data
- Cross-listing search and sample:
  - Control cross-listings obtained for Brazil-Argentina, Singapore-Hong-Kong, France-Germany; selection limited by DataStream availability.
  - CARICOM sample: 9 firms generating 11 cross-premium series: 8 Trinidad and Tobago-Jamaica series (TTO-JAM), 3 Trinidad and Tobago–Barbados series (TTO-BRB) (note: the 9 firms generated 11 series).
- Data filtering:
  - Kept series with more than 100 trading days.
  - Excluded days without positive trading volume in both markets.
- Liquidity and trading frequency:
  - Average number of week days between two simultaneous trading days in CARICOM sample: 5.4 (more than twice what is observed for Hong-Kong–Singapore or France–Germany cross-listings).
- Cross-market premium definition:
  - p_t = 100 * (S1_t / ER1_t - S2_t / ER2_t) / (S2_t / ER2_t)  (premium defined using exchange rates ER1, ER2 and stock prices S1, S2).
- Observed premium magnitudes:
  - Premiums for CARICOM cross-listed stocks are greater than 3 percent and comparable to illiquid emerging-market stocks in Levy Yeyati et al. (2006).

### B. AR Results (estimation and major findings)
- Estimation strategy:
  - AR regressions on the premium with GARCH(1,1) corrections for conditional heteroscedasticity and serial correlation.
  - Mean equation includes three lags of dependent variable; variance equation includes ARCH(1) (α1) and GARCH(1) (λ1) terms.
  - Quasi-Maximum Likelihood Estimator used to accommodate non-normality of errors.
- Statistical significance:
  - All beta-coefficients have expected (negative) sign; all but two coefficients are highly significant.
- Half-life estimates:
  - Time unit: period between two simultaneous trading days.
  - Reported results:
    - Average half-life for TTO-JAM premium: 18 week days.
    - TTO-JAM half-life is 9 times higher than France–Germany or Argentina–Brazil cross-listings, and more than twice larger than Singapore–Hong-Kong estimate.
    - BRB-TTO half-life larger than TTO-JAM due to very low liquidity in BSE.
  - Interpretation nuances:
    - Half-lives reported in simultaneous trading days (regression half-lives) are shorter than calendar-week-day-adjusted half-lives because the number of non-trading days inflates calendar measures.
    - When measured in simultaneous trading days, Caribbean half-lives are shorter than between Singapore and Hong-Kong and of the same order of magnitude as Argentina–Brazil.
- Liquidity vs. arbitrage:
  - Putting illiquidity aside, there appear to be no major barriers to arbitrage trading within the Caribbean; however, illiquidity substantially hampers market functioning and thus financial integration.
- Potential bias from third efficient cross-listings:
  - Some Caribbean stocks (GKC and GHL) are cross-listed in advanced markets; such listings could facilitate price discovery and potentially bias measures of intra-regional convergence.
  - The paper checks for this effect (results reported in table 7 in the source).

*Source: IMF staff working paper section "3. Convergence Speed vs. Foreign Liabilities" (excerpt).*

### conclusion (that Caribbean stock markets are not well integrated) using a regression linking

### _wp09139 - conclusion (that Caribbean stock markets are not well integrated) using a regression linking

### Stock market price convergence and non-linear dynamics (TAR estimator)
- TAR model separates “small” and “large” arbitrage opportunities, estimating speeds of convergence β_in (in-band) and β_out (out-of-band) and an endogenously chosen threshold (neutral band).
- Optimal threshold value: relatively high (column a, 8.1 on average for the TTO-JAM premium) and of the same order of magnitude as the mean absolute premium.
- Estimated speeds:
  - β_out coefficients are negative (column c).
  - In most cases β_in is also negative and |β_in| < |β_out|, justifying the TAR approach.
- TAR half-life findings:
  - Half-lives outside the neutral band reach an average of around 7.3 week days for the TTO-JAM premium.
  - Comparison benchmark: around 5 days for Hong-Kong and Singapore cross-listings.
- Robustness and alternative estimators:
  - Forcing β_in = 0 (Levy Yeyati et al. (2006)) yields on average c = 8.35, β_out = -0.56 for the TTO-JAM premiums.
  - Obstfeld-Taylor (1997) two-equation estimator gives on average c = 6.4, β_out = -0.57.
  - On de-trended data, neutral bands remain high (around 5) while speeds of convergence out of the band become smaller (around -0.2).
- Caveats:
  - Difference in half-lives for the Caribbean versus other regions is statistically significant but the sample is small.
  - Existence of non-linearities does not automatically imply a proper neutral band; in most series β_in is significantly different from 0 at the 10 percent confidence level.
  - Likelihood ratio tests comparing ARCH-TAR to standard ARCH-AR were not performed because standard inference is not valid under the AR null; Monte-Carlo simulations would be needed.

### Current account convergence and regional/global financial integration (DF panel estimation)
- Theoretical framework: Trehan and Walsh (1991) — stationarity of ca_t (current account as share of GDP) is sufficient for the long-run no-Ponzi condition; speed of adjustment of the current account is a measure of financial integration (Taylor, 2002).
- Panel estimation equation: ∆ca_it = α_i + β_i ca_it-1 + ε_it
- Regional groups pooled for power:
  - i) the CARICOM14 (all CARICOM countries but Montserrat)
  - ii) the EU15 group (Belgium and Luxembourg merged)
  - iii) the MERCOSUR+5 group (10 South American countries)
  - iv) the ASEAN10+3 group (13 countries participating in the Chiang Mai Initiative)
  - v) the ECOWAS15 group (members except Liberia)
- Four estimators used:
  - Mean Group Estimator (MGE)
  - Fixed Effects (FE) / Pooled OLS (POLS) / Random Effects (RE) as appropriate
  - Levin, Lin and Chu (LLC, 2002)
  - Arellano and Bond GMM (to correct Nickell bias)
- Estimation results and interpretation:
  - All estimators confirm negative beta for all periods and regions; standard errors reported as small.
  - CARICOM beta: -0.4 (close to the world average), indicating lower integration than EU15 or ASEAN+3 but better than MERCOSUR+5 and ECOWAS15.
  - Levin-Lin-Chu test confirms stationarity of the current account at the 1 percent level for all regions.
  - Cross-validation with external data:
    - Correlation between beta-coefficient and log of volume of foreign liabilities (percent of GDP, 1975-2005 average): 0.35 for all countries, 0.66 after removing the 5 most obvious outliers.
  - Fixed-effects regression with CARICOM dummy:
    - ∆ca_it = α_i + β_i ca_it-1 + β_i^C ca_it-1 I{CARICOM} + ε_it
    - β_i^C was significantly positive (suggesting CARICOM beta less negative than MERCOSUR+5) but significance is not robust to heteroscedasticity adjustments.
- Sub-period analysis:
  - Data split into 1975–90 and 1991–2005.
  - All estimators indicate larger speed of adjustment for the early period (1975–90) across regions.
  - Except for the LLC estimator, all estimators point at CARICOM14 as the least integrated region until the 1990s.
  - Conclusion: CARICOM14 has become more integrated in recent decades; levels of financial integration above other LDCs but below EU15 and ASEAN+3.

### Intra-regional trade balance dynamics and regional financial integration
- Regional trade importance:
  - Trade with other CARICOM countries is significant, with exports approaching 10 percent GDP in recent years.
  - Regional trade imbalances account for more than 40 percent of current account deficits for most CARICOM countries.
- Panel model for regional trade balance (ca*_it):
  - ∆ca*_it = α_i + β_i* ca*_it-1 + ε_it
  - MGE estimates average β = -0.34 (lower than the beta for global integration).
  - Interpretation caution: regional deficit can be offset by world trade integration or borrowing from outside the region.
- Extended model controlling for extra-regional current account ca' = ca − ca*:
  - ∆ca*_it = α_i + β_i* ca*_it-1 + γ_i ∆ca'_it + δ_i ca'_it-1 + ε_it
  - Interpreted as ∆ca*_it − γ_i ∆ca'_it = α_i + β_i* ca*_it-1 + δ_i ca'_it-1 + ε_it
  - Interpretation of coefficients:
    - γ_i < 0: extra-regional current account adjusts when regional trade balance is in deficit.
    - γ_i = -1: symmetric adjustment between ca' and ca*.
    - γ_i ≈ 0: indicates low world financial integration (large needed adjustment in extra-regional trade balance).
  - Estimators used for this specification: MGE, FE, Arellano-Bond (LLC not applicable).
  - MGE favored for heterogeneity; MGE results give β and γ with expected signs and low standard errors.
  - Examples:
    - MERCOSUR+5: γ estimate is 0 (lack of integration to world markets).
    - ASEAN+3: highly integrated to world markets (γ large in magnitude).
    - CARICOM14: intermediate—less integrated than developed countries but better than MERCOSUR+5 and ECOWAS15.
- Regional ranking robustness:
  - MGE places CARICOM14 in the middle; FE and Arellano-Bond produce differing (less intuitive) rankings (e.g., ECOWAS15 appearing highly integrated under Arellano-Bond).
- Pre/post-1990 application:
  - CARICOM still ranks 3rd, far from ASEAN13, but improves relative to MERCOSUR+5 in the post-1990 period.
  - Overall indication: financial integration (global and regional) improving in CARICOM in recent decades.

### Cross-cutting empirical findings and key statistics
- TAR threshold and convergence:
  - Optimal threshold (TTO-JAM premium): average 8.1.
  - Half-life out-of-band (TTO-JAM): around 7.3 week days.
  - Half-life benchmark for Hong-Kong and Singapore cross-listings: around 5 days.
  - Forced β_in = 0 results: c = 8.35, β_out = -0.56.
  - Obstfeld-Taylor two-equation estimator: c = 6.4, β_out = -0.57.
  - De-trended data: neutral bands ~5, β_out ≈ -0.2.
- Current account / integration statistics:
  - CARICOM beta: -0.4.
  - MGE average β for regional trade balance: -0.34.
  - Correlation between beta and log foreign liabilities: 0.35 (all countries), 0.66 (after removing 5 outliers).
  - Exports to CARICOM partners: approaching 10 percent GDP (recent years).
  - Regional trade imbalances contribution: more than 40 percent of current account deficits for most CARICOM countries.
- Sample and periods:
  - Main sub-periods analyzed: 1975–90 and 1991–2005.
  - Regional groups: CARICOM14, EU15, MERCOSUR+5, ASEAN10+3 (ASEAN13), ECOWAS15.

### Policy-relevant conclusions and recommendations
- Primary conclusions:
  - Price-based evidence and TAR estimates indicate slow price convergence in the Caribbean; half-lives are higher than in more integrated markets even after controlling for number of cross-listings.
  - Macroeconomic (current account) evidence positions CARICOM14 in the middle of studied regions: more integrated than some LDC groups but lagging EU15 and ASEAN+3.
  - Regional financial integration appears to have improved in the last two decades, though rankings are sensitive to estimator choice.
- Policy challenges identified:
  - Illiquidity and market functioning:
    - Despite high debt levels and large stock market capitalization, re-trading is almost inexistent in bond markets and inefficient in stock markets.
    - Institutional barriers (e.g., inefficient settlement systems) likely impede market functioning.
  - Dependence on transient flow drivers:
    - Recent large regional flows were mostly driven by Trinidad and Tobago’s current account surpluses (oil-price related).
    - Risk that these flows may vanish with low oil prices; ensuring persistence of regional flows is critical.
- Policy implications and priorities:
  - Strengthen market infrastructure and institutional frameworks to improve liquidity and efficiency in equity and debt markets (e.g., settlement systems).
  - Design policies to sustain regional flows beyond commodity-driven surpluses to reduce vulnerability to commodity price cycles.
  - Continue monitoring and promoting both regional and global financial integration, with attention to heterogeneity across countries and sensitivity to estimation methods.

*Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2009/_wp09139.pdf*

### REFERENCES

### _wp09139 - REFERENCES

### Journal articles
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- Bayoumi, T.A., and A.K. Rose, 1993, “Domestic Savings and Intra-National Capital Flows,” European Economic Review, Vol. 37, pp 1197–1202, August.
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- Feldstein, M., and C. Horioka, 1980, “Domestic Saving and International Flows,” Economic Journal, Vol. 358, pp. 314–29.
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- Lee, K., M.H. Pesaran, and R. Smith, 1997, “Growth and Convergence in a Multi-Country Empirical Stochastic Solow Model,” Journal of Applied Econometrics, Vol. 12, pp 357–392.
- Levin, A., C.-F. Lin and C.-S. J. Chu, 2002, “Unit Root Tests in Panel Data: Asymptotic and Finite Sample Properties,” Journal of Econometrics, Vol. 108, pp 1–24.
- Miller, M.H., J. Muthuswamy, and R.E. Whaley, 1994, “Mean Reversion of Standard & Poor's 500 Index Basis Changes: Arbitrage-Induced or Statistical Illusion?,” Journal of Finance, Vol. 49, pp. 479–513.
- Obstfeld, M., and A. Taylor, 1997, “Nonlinear Aspects of Goods-Market Arbitrage and Adjustment: Hechkscher’s Commodity Points Revisited,” Journal of the Japanese and International Economies, Vol. 11, pp 441–479.
- Pesaran, M.H., and R. Smith, 1995, “Estimating Long-Run Relationships from Dynamic Heterogeneous Panels,” Journal of Econometrics, Vol. 68, pp. 79–113.
- Rayhorn, C., M.K. Hassan, J.-S. Yu, and K.R. Janson, 2007, “Emerging Market Efficiencies: New Zealand's Maturation Experience in the Presence of Non-Linearity, Thin Trading and Asymmetric Information,” International Review of Finance, Vol. 7, pp. 21–34.
- Solibakke, P.B., 2001, “Efficiency ARMA-GARCH Estimated Trading Volume Characteristics in Thinly Traded Markets,” Applied Financial Economics, Vol. 11, pp. 539–556.
- Taylor, M., 1995, “The Economics of Exchange Rates,” Journal of Economic Literature, Vol. 33, pp. 13–47.
- Taylor, A., 2002, “A Century of Current Account Dynamics,” Journal of International Money and Finance, Vol. 2, pp 725–748.
- Trehan, B., and C.E. Walsh, 1991, “Testing Intertemporal Budget Constraints: Theory and Applications to the U.S. Federal Budge and Current Account Deficits,” Journal of Money, Credit and Banking, Vol. 23, pp. 206–223.
- Zhang J., A. van Witteloostuijn and C. Zhou, 2005, “Chinese Bilateral Intra-Industry Trade: A Panel Data Study for 50 Countries in the 1992–2001 Period,” Review of World Economics, Vol. 141, pp. 510–40.

### Working papers, IMF reports, and institutional studies
- Adam, K., T. Jappelli, A. Menichini, M. Padula and M. Pagano, 2002, “Analyse, Compare, and Apply Alternative Indicators and Monitoring Methodologies to Measure the Evolution of Capital Market Integration in the European Union,” CSEF Working Paper (Naples: Centre for Studies in Economics and Finance).
- Cashin, P., M. S. Kumar and C. J. McDermott, 1995, “International Integration of Equity Markets and Contagion Effects,” IMF Working Paper No. 95/110 (Washington: International Monetary Fund).
- Cowen, D., R. Salgado, H. Shah, L. Teo and A. Zanello, 2006, “Financial Integration in Asia: Recent Developments and Next Steps,” IMF Working Paper 06/196 (Washington: International Monetary Fund).
- Kwon, G., S. Panth, J. Chai, A. Gerson, G.M. Casselle and R. Espinoza, 2008, “Financial Integration in the Caribbean,” in A. Bauer, P. Cashin and S. Panth (editors), The Caribbean: Enhancing Economic Integration, IMF Western Hemisphere Department, Washington DC: International Monetary Fund, pp. 3–43.
- Levy Yeyati, E., S.L. Schmukler and N. Van Horen, 2006, “International Financial Integration through the Law of One Price,” World Bank Working Paper WPS2897 (Washington: The World Bank).
- Ronci, M., 2004, “Trade Finance and Trade Flows: Panel Data Evidence from 10 Crises,” IMF Working Paper 04/225 (Washington: International Monetary Fund).
- Rose, A.K., and M. Spiegel, 2002, “A Gravity Model of Sovereign Lending: Trade, Default and Credit,” NBER Working Paper No. 9285 (Cambridge MA: National Bureau of Economic Research).
- IMF, 2006, “Trinidad and Tobago: Financial System Stability Assessment,” IMF Country Report No. 06/29.
- TTSEC, 2004, “Development of the Securities Market in Trinidad and Tobago, 1997 to 2003, with Prospects for the Future,” Trinidad and Tobago Securities and Exchange Commission, Research Division.

### Books, book chapters, and edited volumes
- Brenner, P., and R.A. Morales, 2006, “Consolidated Supervision of Financial Groups in Central America,” in P. Brenner (editor) Central America: Structural Foundations for Regional Financial Integration (Washington: International Monetary Fund).
- Chai, J., 2006, “The Eastern Caribbean Currency Union Banking System in a Time of Fiscal Challenge,” in R. Sahay, D.O. Robinson and P. Cashin (editors), The Caribbean: From Vulnerability to Sustained Growth, Washington DC: International Monetary Fund, pp. 143–180.
- Chai, J., and R. Goyal 2006, “Tax Concessions and Foreign Direct Investment in the Eastern Caribbean Currency Union,” in R. Sahay, D.O. Robinson and P. Cashin (editors), The Caribbean: From Vulnerability to Sustained Growth, Washington DC: International Monetary Fund, pp. 258–284.
- Obsfeld, M., and A. Taylor, 2004, “Global Capital Markets: Integration, Crisis, and Growth”, Cambridge, UK: Cambridge University Press.
- Park, Y.C., and K.-H. Bae, 2002, “Financial Liberalization and Economic Integration in East Asia,” PECC Finance Forum Conference on Issues and Prospects for Regional Cooperation for Financial Stability and Development.
- Tong, H., 1978, “On a Threshold Model”, in C.H. Chen (editor) Pattern Recognition and Signal Processing, Amsterdam: Sijthoff and Noordhoff.

### Technical notes, methods, and software
- Baum, C., and F. Bornhorst, 2006, “’LEVINLIN': module to perform Levin-Lin-Chu panel unit root test”, STATA module.
- Levin, A., and C.-F. Lin, 1992, “Unit Root Tests in Panel Data: Asymptotic and Finite-sample Properties,” University of California-San Diego Discussion Paper 92–23 (San Diego: University of California-San Diego).
- Kim, S., J.-W. Lee and K. Shin, 2005, “Regional and Global Financial Integration in the East-Asia,” Working Papers 0602, Institute of Economic Research, Korea University (Seoul: Institute of Economic Research).

*Source: _wp09139 - REFERENCES*

### APPENDIX A

### APPENDIX A

### Methodology: band-TAR–GARCH specification
- Estimated a band-TAR model on the cross-market premium p_t following Levy Yeyati et al (2006).
- Threshold c>0. Single-equation approach: both AR-in and AR-out coefficients are estimated in one equation using two explanatory variables:
  - the value of premium if it is inside the band, 0 otherwise;
  - the difference between the premium and c if the premium is outside the band, 0 otherwise.
- Corrected for ARCH and GARCH effects and for serial correlation, and relied on the Quasi-Maximum Likelihood Estimator (QMLE).
- Mean and variance specification:
  - First equation is the mean equation.
  - Second equation is the variance equation characteristic of GARCH models with one ARCH lag (coefficient α1) and one GARCH lag (coefficient λ1).
- The single-equation GARCH approach forces the behaviour of the error term and the conditional variance to be the same in the two segments; an alternative split-sample approach was attempted but often failed to converge due to reduced sample size (footnote 24).
- De-trended regressions were also run with the constant μ removed; results were on average similar (footnote 25).

### Threshold selection and estimation details
- Threshold c chosen optimally by maximum likelihood: for each c in a certain range the likelihood L_TAR(c) is computed and the c that maximizes L_TAR is selected.
- Range used: c ∈ [p_10th ; p_90th], where p_10th and p_90th are the 10th and 90th percentiles of the distribution of p, to ensure each regression uses at least 10 percent of the data (footnote 26).
- c is incremented by steps of 0.1.
- Sometimes the GARCH model did not converge for the smallest and largest values of c; in that case estimation results were discarded for these thresholds.
- The TAR–GARCH model requires a long span of data for convergence and robustness; method less useful for the least liquid stocks.
- The GARCH lag was removed for RBTT and FCIB because it prevented convergence of the ML estimator.
- Results reported in Table 10.

### Key estimation and diagnostic characteristics
- GARCH specification: one ARCH lag (α1) and one GARCH lag (λ1) in the variance equation.
- Use of dummies I_in and I_out to generate the two sampled explanatory variables for in-band and out-of-band observations.
- Estimation relied on QMLE with corrections for serial correlation and conditional heteroskedasticity.

### Selected (G)ARCH–TAR results (excerpts from Table 10)
- TTO-JAM premium (out band):
  - c (out band): 8.1
  - Week: -0.1
  - days: -0.43
  - half-life 1: 31.43
  - half-life 2: 37.26
- GKC:
  - c (out band): 6.5
  - Week: -0.2 ***
  - days: -0.35 ***
  - half-life 1: 1.58
  - half-life 2: 5.24
  - β_in/β_out/α1/λ1 references in table
- JMMB:
  - c (out band): 14.3
  - Week: -0.1 **
  - days: -0.64 ***
  - half-life 1: 0.67
  - half-life 2: 1.59
- RBTT (no GARCH):
  - c (out band): 4.2
  - Week: -0.4 *
  - days: -0.39 ***
  - half-life 1: 1.39
  - half-life 2: 12.84
- FCIB (no GARCH):
  - c (out band): 7.3
  - Week: -0.4
  - days: -0.49 ***
  - half-life 1: 1.03
  - half-life 2: 8.03
- NCBJ:
  - c (out band): 2.2
  - Week: 0.7
  - days: -0.23 ***
  - half-life 1: 2.69
  - half-life 2: 5.69
- CCMB:
  - c (out band): 11.4
  - Week: -0.2 ***
  - days: -0.28 **
  - half-life 1: 2.07
  - half-life 2: 5.59
- DBG:
  - c (out band): 4.9
  - Week: 0.46 ***
  - days: -0.66 ***
  - half-life 1: 0.64
  - half-life 2: 1.78
- GHL:
  - c (out band): 14.1
  - Week: -0.4 ***
  - days: -0.41 ***
  - half-life 1: 1.33
  - half-life 2: 17.35
- Notes:
  - Significance markers such as *, **, *** are preserved exactly as in Table 10.
  - Several entries in Table 10 report "n.a." where statistics are not available due to model adjustments (e.g., GARCH lag removal).
  - Half-life measures reported as half-life 1 and half-life 2 are calculated based on β coefficients and the number of days between simultaneous trading (footnotes in table).

### Broader tables and comparative findings (referenced)
- Table 9 reports (G)ARCH–AR model results including β coefficients and half-life measures for several cross-listed stocks; notable β values include:
  - TTO-JAM premium half-life 1: 3.81 and half-life 2: 8.3
  - RBTT β: -0.18 (GARCH lag noted)
  - FCIB β: -0.18
  - See Table 9 for full list and significance indicators.
- Tables 11–16 present β, γ, δ estimates for regional financial integration across regions and periods:
  - Table 11: β Coefficient from 1975–2005 (examples)
    - EU15 entries include values such as -0.25 and -0.03 repeated in panel formats.
    - CARICOM14 entries include -0.4 and -0.04.
  - Table 12: β Coefficient from 1975–90 (examples)
    - EU15: -0.47 and -0.06
    - CARICOM14: -0.54 and -0.06
  - Table 13: β Coefficient from 1991–2005 (examples)
    - EU15: -0.25 and -0.05
    - MERCOSUR+5: -0.46 and -0.08
  - Table 15 (1975–90 Estimates): regional MGE, Fixed effects, and Arellano-Bond estimates with specific β, γ, δ numbers and standard errors in parentheses (examples preserved exactly in the source).
  - Table 16 (1991–2005 Estimates): MGE β, γ, δ examples:
    - ASEAN13: -0.26 (0.05), -0.38(0.06), -0.15 (0.05)
    - EU15: -0.27 (0.06), -0.24(0.05), -0.09 (0.04)
    - CARICOM14: -0.37 (0.05), -0.03(0.02), -0.02 (0.02)
- Figure captions and regressions:
  - Figure 3 reports a regression: y= -0.438 + 0.041 x (0.014) relating convergence speed to ln(Foreign Liabilities/GDP).
  - Figure 1 reports cross-country sigma-convergence with trend y=37.9 - 0.66 t (0.008).

*Source: APPENDIX A, _wp09139.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2009/_wp09139.pdf_