Recent Advances in International Finance: Introduction

Arguably, international finance is one of the most exciting areas in economics. The development of international finance is influenced and shaped, at least in part, by the continuing process of globalization and integration. In the last 25 years the profession has witnessed the proliferation of both theoretical models and empirical analyses in international finance. The analysis of both new and existing issues has benefited from increasingly elaborate modelling techniques and sophisticated empirical tools. Given its rapid and diverse developments, it is infeasible, if not impossible, to prepare an issue for the Pacific Economic Review that will highlight, in a balanced manner, the current landscape in international finance. Thus, this special issue on ‘Recent Advances in International Finance’ is bound to be selective, and to cover some but not all the important and interesting developments. We have ended up with five articles for this issue – three from the USA and two from the UK. They can be summarized as follows. There is an ongoing, and at times contentious, debate on the implications of the economic integration that has been steadily occurring throughout recent decades. A fundamental issue is how to assess the degree of integration between economies or markets in different geographical locations. Robert Flood and Andrew Rose, in ‘A New Approach to Asset Integration: Methodology and Mystery’, propose an alternative method for measuring financial market integration. Their method is based on the argument that when markets are integrated assets should not have market-specific discount rates. Thus, markets should be integrated when assets in these markets are all priced by the same (and, possibly, time-varying) discount rate. Under a general intertemporal pricing framework and the assumptions of rational expectations and constant asset-specific systematic risk, one can estimate the unobservable discount rate for each asset (or portfolio). Then the estimated discount rates can be used to test whether the unobservable discount rates are the same across assets (portfolios). Applying the proposed test for integration, Flood and Rose find that the S&P 500 market is integrated; other markets, however, including NASDAQ, the Toronto Stock Exchange and the US bond markets, are not. Further, there is no evidence of integration between these markets. The purchasing power parity (PPP) hypothesis is perhaps the international parity condition that has been examined the most in recent years. One of the * Address for correspondence : Yin-Wong Cheung, Department of Economics, University of California, Santa Cruz, CA 95964; Email: [email protected].