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Measuring Financial Integration Via Idiosyncratic Risk: What Effects are We Really Picking Up?

8 Pages Posted: 12 Jul 2006  

David C. Parsley

Vanderbilt University - Finance

Christian Schlag

Goethe University Frankfurt - Research Center SAFE

Date Written: 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 Classification: F36, G10

Suggested Citation

Parsley, David C. and Schlag, Christian, Measuring Financial Integration Via Idiosyncratic Risk: What Effects are We Really Picking Up? (March 2006). Available at SSRN: https://ssrn.com/abstract=895212 or http://dx.doi.org/10.2139/ssrn.895212

David C. Parsley (Contact Author)

Vanderbilt University - Finance ( email )

401 21st Avenue South
Nashville, TN 37203
United States
615-322-0649 (Phone)
615-343-7177 (Fax)

Christian Schlag

Goethe University Frankfurt - Research Center SAFE ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany
+49 69 798 33699 (Phone)
+49 69 798 33901 (Fax)

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