A Measure of Stock Market Integration for Developed and Emerging Markets

June 1995
Along several dimensions, a measure of the financial integration of equity markets yields results consistent with prior assumptions about the relationship between effective integration, explicit capital controls, capital market development, and economic growth.
If equity markets are financially integrated, the price of risk should be the same across markets. If the markets are not financially integrated---possibly because of barriers to capital flows across markets---the price of risk may differ across markets.
Korajczyk investigates one measure of financial integration between equity markets. He uses a multifactor equilibrium Arbitrage Pricing Theory to define risk and to measure deviations from the law of one price. He applies the integration measure to equities traded in 24 countries (four developed, and 20 emerging).
The measure of market segmentation tends to be much larger for emerging markets than for developed markets, which is consistent with larger barriers to capital flows into or out of the emerging markets.
The measure tends to decrease over time, which is consistent with growing levels of integration.
Large values of adjusted mispricing occur around periods of economic turbulence and periods in which capital controls change significantly. So, the adjusted mispricing estimates measure not only the level of deviation from the law of one price, but also the revaluations inherent in moving from one regime to another.
This paper---a product of the Finance and Private Sector Development Division, Policy Research Department---is part of a larger effort in the department to study stock market development. The study was funded by the Bank's Research Support Budget under the research project Stock Market Development and Financial Intermediary Growth (RPO 678-37).