Barney School of Business Associate Professor Ke Yang, and Professors Susan Wahab, Bharat Kolluri and Mahmoud Wahab’s chapter “A Non-Parametric Examination of Emerging Markets Financial Integration” will appear in The Handbook of Financial Econometrics, Mathematics, Statistics, and Technology, Volume 4, in 2019.
Abstract: Prior studies on financial markets integration use parametric estimators whose underlying assumptions of linearity and normality are questionable, at best, particularly when using high frequency data. We re-examine the evidence regarding financial integration trends of 14 emerging equity markets from Southeast Asia, Latin America, the Middle East, along with the U.S. and Japan using non-parametric estimators of adjusted R2 as a measure of financial integration measure. Results from the non-parametric estimator are contrasted to those of parametric estimator of adjusted R2 and simple correlation (SC)using bi-daily returns for contiguous yearly sub-periods from 1993 to 2016. We find two key results. First, we confirm prior evidence in Pukthuanthong and Roll (2009) that (SC) understates financial integration compared to parametric adjusted R2. Second, our data indicate parametric adjusted R2 understates financial integration relative to non-parametric adjusted R2. These results suggest emerging equity markets may be more financially integrated, offering fewer diversification benefits to global investors than previously thought. Future research should exercise caution when estimating financial integration trends using parametric methods.