Working Paper: CEPR ID: DP4027
Authors: Robert P. Flood; Andrew K. Rose
Abstract: 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 constrained 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. The NASDAQ, however, is poorly integrated with the S&P 500.
Keywords: Asset; Conditional Expected; Intertemporal Market Price; Rate; Risk-Free; Stock
JEL Codes: F32; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| expected risk-free rates (G12) | asset integration (G31) |
| marginal rate of substitution (D11) | asset integration (G31) |
| S&P 500 integration (G12) | NASDAQ integration (G24) |
| marginal rate of substitution volatility (D11) | integration between S&P 500 and NASDAQ (G12) |