Characterizing World Market Integration Through Time

Abstract

International asset pricing models suggest that barriers to portfolio flows and availability of market substitutes affect the degree and time variation of world market integration. We construct diversification portfolios for eight emerging markets over the period 1976-2000, use GARCH-M methodology to estimate the Errunza-Losq model and empirically assess the time variation in market integration. Our results suggest that although local risk is the most relevant factor in explaining time-variation of emerging market returns, global risk is also conditionally priced for some countries. Further, there are substantial cross-market differences in the degree of integration. We find evidence of a significant increase in the degree of integration during the last decade. Our results suggest the impropriety of directly using correlations of marketwide index returns as a measure of market integration. Finally, financial market development, macroeconomic development and financial liberalization policies play important roles in integrating emerging markets.