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Measuring Financial Integration via Idiosyncratic Risk: What Effects Are We Really Picking Up?
David C. Parsley Vanderbilt University - Owen Graduate School of Management Christian Schlag Goethe University Frankfurt - Department of Finance March 2006 Abstract: We study the method proposed by Flood and Rose (FR, 2004, 2005) for checking for financial integration by estimating the risk-free rate using the idiosyncratic component of individual stock returns. Performing simulations with data with a known return generation process, we find that the FR methodology produces poor estimates of the risk-free rate, and hence the FR method fails to accept integration when true. We then show analytically that the FR method actually provides an estimate of the market return, and conclude the FR methodology would also falsely accept integration as long as the market returns in the two markets do not differ widely.
Keywords: financial market integration, risk-free rate JEL Classifications: F36, G10 Working Paper SeriesDate posted: July 12, 2006 ; Last revised: August 24, 2006Suggested CitationContact Information
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