Financial Integration: A New Methodology and An Illustration
June 1, 2004
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Summary
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 a factor model of covariances over short time periods. We find that implied expected risk-free rates vary dramatically over time, unlike short interest rates. Further, internal integration in the S&P 500 market is never rejected and is generally not rejected in the NASDAQ. Integration between the NASDAQ and the S&P, however, is always rejected dramatically.
Subject: Asset prices, Econometric analysis, Factor models, Financial institutions, Financial markets, Prices, Stock markets, Stocks, Time series analysis
Keywords: asset, Asset prices, conditional, cross-market condition, expected, Factor models, intertemporal, market, NASDAQ market, NASDAQ portfolio, open-economy asset-market integration concept, portfolio variance, price, rate, risk-free, Standard and Poor's, stock, Stock markets, Stocks, Time series analysis, WP
Pages:
20
Volume:
2004
DOI:
Issue:
110
Series:
Working Paper No. 2004/110
Stock No:
WPIEA1102004
ISBN:
9781451853377
ISSN:
1018-5941
