FINANCIAL INTEGRATION: A NEW METHODOLOGY AND AN ILLUSTRATION

This paper develops a simple methodology to test for asset integration, and applies it within and between American stock markets. Our technique 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 must be equal across (risk‐adjusted) assets in well‐integrated markets. Assets are allowed to have standard risk characteristics, and are constrained by the Fama and French factor model of covariances over short time periods. We find that internal integration in the S&P 500 market is never rejected and is not generally rejected in the NASDAQ. Integration between the NASDAQ and the S&P, however, is always rejected dramatically. (JEL: G14)