International Financial Integration Through the Law of One Price

43 Pages Posted: 15 May 2006

See all articles by Eduardo Levy Levy-Yeyati

Eduardo Levy Levy-Yeyati

Universidad Torcuato Di Tella - School of Business

Sergio L. Schmukler

World Bank - Development Research Group (DECRG)

Neeltje van Horen

Bank of England; Centre for Economic Policy Research (CEPR)

Date Written: April 2006

Abstract

This paper argues that the cross-market premium (the ratio between the domestic and the international market price of cross-listed stocks) provides a valuable measure of international financial integration, reflecting accurately the factors that segment markets and inhibit price arbitrage. Applying to equity markets recent methodological developments in the purchasing power parity (PPP) literature, we show that non-linear Threshold Autoregressive (TAR) models properly capture the behavior of the cross-market premium. The estimates reveal the presence of narrow non-arbitrage bands and indicate that price differences outside these bands are rapidly arbitraged away, much faster than what has been documented for good markets. Moreover, we find that financial integration increases with market liquidity. Capital controls, when binding, contribute to segment financial markets by widening the non-arbitrage bands and making price disparities more persistent. Crisis episodes are associated with higher volatility, rather than by more persistent deviations from the law of one price.

Keywords: capital market integration, market segmentation, TAR, PPP, capital controls, crisis

JEL Classification: F30, F36, G15

Suggested Citation

Levy-Yeyati, Eduardo Levy and Schmukler, Sergio and van Horen, Neeltje, International Financial Integration Through the Law of One Price (April 2006). World Bank Policy Research Working Paper No. 3897. Available at SSRN: https://ssrn.com/abstract=902249

Eduardo Levy Levy-Yeyati

Universidad Torcuato Di Tella - School of Business ( email )

Saenz Valiente 1010
C1428BIJ Buenos Aires
Argentina

Sergio Schmukler

World Bank - Development Research Group (DECRG) ( email )

1818 H. Street, N.W.
MSN MC 3-301
Washington, DC 20433
United States
202-458-4167 (Phone)
202-522-3518 (Fax)

HOME PAGE: http://www.worldbank.org/en/about/people/s/sergio-schmukler

Neeltje Van Horen (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

HOME PAGE: http://https://www.bankofengland.co.uk/research/Researchers/neeltje-van-horen

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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