Global Market Integration: An Alternative Measure and Its Application

Many previous studies of international markets have attempted to measure integration by correlations among broad stock market indexes. Yet such correlations have been found to poorly mimic other measures of integration. We show that a simple correlation between two stock markets is likely to be a poor indicator of integration for a very simple reason: when there are multiple factors driving returns, such as global macro factors or even industry factors, two markets can be perfectly integrated and yet still be imperfectly correlated. Perfect integration implies that the same international factors explain 100% of the broad index returns in both countries, but if country indexes differ in their sensitivities to these factors, they will not exhibit perfect correlation. We derive a new integration measure based on the explanatory power of a multi-factor model and use it empirically to investigate recent trends in global integration. For most countries, there has been a marked increase in measured integration, but this is not indicated by simple correlations among country indexes.