Financial Integration: A New Methodology and An Illustration

Andrew K. Rose, Robert P. Flood
2004 IMF Working Papers  
This paper develops a simple new methodology to test for asset integration and applies it within and between American stock markets. Our technique is tightly based on a general intertemporal asset-pricing model, and 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 are equal across (risk-adjusted) assets. Assets are allowed to have general risk characteristics, and are
more » ... onstrained only by a factor model of covariances over short time periods. The technique is undemanding in terms of both data and estimation. We find that expected risk-free rates vary dramatically over time, unlike short interest rates. Further, the S&P 500 market seems to be well integrated, and the NASDAQ is generally (but not always) integrated. However, the NASDAQ is poorly integrated with the S&P 500. JEL Classification Numbers: G14
doi:10.5089/9781451853377.001 fatcat:p2td4ejqfbfrvcw7kf53svelri