Vol.22, No.2 / May 2004

Equity Integration in Japan:
An Application of a New Method

Andrew K. Rose

This paper develops a simple new methodology to test for asset integration and applies it to the Japanese stock market as represented by the Tokyo Stock Exchange (TSE). The technique is tightly based on a general intertemporal asset-pricing model, and 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 are equal across (risk-adjusted) assets. Assets are allowed to have general risk characteristics, and are constrained only by a factor model of covariances over short time periods. The technique is undemanding in terms of both data and estimation. I find that expected risk-free rates vary dramatically over time, unlike short-term interest rates. Further, the TSE does not always seem to be well integrated in the sense that different portfolios of stocks are priced with different implicit risk-free rates.

Key words: Stock prices; Risk; Portfolio

Views expressed in Monetary and Economic Studies are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.

Copyright 2004 Bank of Japan All Rights Reserved.