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ABSTRACT
Through a survey of literature in the measurement of financial integration (FI), this study explores the historical footprints on the measurement of financial integration, key issues, and challenges. We document the evolution of measurements during 1980–2018 and extend the measurement classification with specific criteria associated with the measurements. Furthermore, this study identifies the strength and weaknesses of existing measurements and highlights the need and criteria for choosing an appropriate measure. Finally, our study concludes that as one of the pillars of globalization, appropriate quantification of FI is a major challenge and crucial for monitoring the level and effect of FI for an economy.
Notes
1. Reserve Bank of India (Citation2007) defined “financial integration as a process of unifying the financial markets in a proper way that risk adjusted returns on financial instruments of different countries should be equal when returns are expressed in single currency”. Whereas International Monetary Fund (Citation2016) defined “financial integration is a process through which the financial markets of two or more countries or regions become more connected to each other”. The short form FI is used for financial integration in this article. Further, FI indicators and FI measures are used simultaneously in this article.
2. These articles were selected based on their relevance to the present research questions related to FI such as measurement and classification. Further, these articles are also chosen on the following grounds: (1) need for a measure; (2) suitability and justification of the measure, and (3) economic implication of the measure. As it is not possible to include all studies on FI, we have carefully chosen the literature that are associated with the origin of the measures and adopted subsequently for the empirical testing.
3. Arbitrage is the practice of buying in one place and selling in another at a same time to reap benefits of the price differential in two or more markets.
4. It describes the fact that the investors will hold only a smaller amount of foreign portfolio but preferred to keep domestic portfolios in large quantity.
5. De jure measures are the imposition of legal restrictions on cross-border capital transactions.
6. Macro prudential regulation is the financial regulation that aims at maintaining financial stability and avoid systematic risk to the financial system.
7. Financial Repression is the policies that increases demand for government bonds to lower the borrowing costs of the government to avoid the debt trap. For example, higher inflation.
8. It is the difference between the face value and the production costs of coins. The larger the difference, higher the revenue of the government.
9. The indicators are categorized into three categories: (1) De jure, (2) De facto, and (3) hybrid measures. De Jure measures represent the legal restriction on capital account and act as a proxy for prerequisites of FI. Whereas De facto measures are associated with the information on actual flows, price convergence, and return on assets. Finally, the hybrid measures are the combination of De jure and De facto measures.
10. The short form AREAER is used for Annual Report on Exchange Arrangement and Exchange Restrictions throughout the article.
11. The third category and/or its combination with the second category is used as a dummy to identify the presence of capital account restrictions (Grilli and Milesi-Ferretti Citation1995), whereas the first and fourth categories. do not show any restrictions on capital account transactions and unable to capture the intensity of capital controls.
12. The IMF_BINARY is the 0, 1 converted measure of FI derived from the IMF’s AREAER table restrictions.
13. A type I error is an error associated with the rejection of null hypothesis when it is true.
14. The other three measures also face similar limitations associated with TOTAL. Differently, the first (asset-based measure) and second (liability-based measure) are limited in use because of one-sided focus of investment balance. The fourth measure is limited due to high volatility and data unavailability.
15. They accumulate more external reserves as a preventive measures of financial crisis and will likely to resulted in a higher FI once included.
16. Out of the three, i.e., monetary policy independence, exchange rate stability, and financial market openness, a country can attain only two (Mundell Citation1963).
17. This KOF index covers the social and political dimensions of globalization.