This paper investigates to what extent globalization and regional integration lead to increasing equity market interdependence. I focus on the case of Western Europe, as this region has gone through a unique period of economic, financial, and monetary integration. More specifically, I quantify the magnitude and time-varying nature of volatility spillovers from the aggregate European (EU) and US market to 13 local European equity markets. To account for time-varying integration, I allow the shock sensitivities to change through time by means of a regime-switching model. I find that these regime switches are both statistically and economically important. While both the EU and US shock spillover intensity has increased over the 1980s and 1990s, the rise is more pronounced for EU spillovers. In most countries, shock spillover intensities increased most strongly in the second half of 1980s and the first half of the 1990s. Increased trade integration, equity market development, and low inflation are shown to have contributed to the increase in EU shock spillover intensity. Finally, I find some evidence for contagion from the US market to a number of local European equity markets during periods of high world market volatility.

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Procyclicality has emerged as a potential drawback to adoption of risk-sensitive bank capital requirements. Systematic risk factors may result in increases (decreases) in bank capital requirements when the economy is depressed (overheated), thereby decreasing (increasing) bank lending capacity and exacerbating business cycle fluctuations. Procyclicality may result from systematic risk emanating from common macroeconomic influences or from interdependencies across firms as financial markets and institutions consolidate internationally. We survey the literature on cyclical effects on operational risk, credit risk and market risk measures. Incorporating Systemic Influences Into Risk Measurements: A Survey of the Literature Bank regulations focus on individual institutions. The Basel Capital Accords (both current and proposed) base international bank capital requirements on the measurement of risk for each individual bank. Aggregate capital levels are then obtained by simply adding each bank’s individual capital requirement. To the extent that there is any attention paid to aggregate capital levels at all, it is only as a means to calibrate the

This study examines the financing choices of firms operating in a weak institutional environment. We argue that in relationship-based systems, global financing and strong political connections are alternative means to create firm value. Well-connected firms might be less inclined to access global capital markets because (state-owned) domestic banks provide capital at low cost. Moreover, the expanded disclosures and additional scrutiny that come with issuing foreign securities might be at odds with close political ties at home because these ties can best be exploited when little is disclosed about the firm. Using data from Indonesia, we provide strong support for the hypothesis that global financing and political connections are substitutes: Firms with close political ties to former President Soeharto are significantly less likely than nonconnected firms to have publicly traded foreign securities. To study performance effects, we examine how returns during the Asian financial crisis differ between firms with and without foreign securities. Consistent with prior work, we find that firms with foreign securities exhibit higher returns during the crisis. However, our data indicate that politically well-connected firms also received considerable support during this period. These results suggest that previous estimates of cross-listing benefits are considerably biased if domestic opportunities such as political connections are ignored.

We propose procedures designed to uncover structural breaks in the co-movements of financial markets. A reduced form approach is introduced that can be considered as a two-stage method for reducing the dimensionality of multivariate heteroskedastic conditional volatility models through marginalization. The main advantage is that one can use returns normalized by volatility filters that are purely data-driven and construct general conditional covariance dynamic specifications. The main thrust of our procedure is to examine change-points in the co-movements of normalized returns. The tests allow for strong and weak dependent as well as leptokurtic processes. We document, using a ten year period of two representative high frequency FX series, that regression models with non-Gaussian errors describe adequately their co-movements. Change-points are detected in the conditional covariance of the DM/US$ and YN/US$ normalized returns over the decade 1986-1996. Key words: Change-point tests, conditional covariance, high-frequency financial data, multivariate GARCH models. # The authors would like to thank the special issue editor, Ruey Tsay, two anonymous referees for valuable comments as well as M. Dacorogna for providing us the data. The first author is also grateful to the Marie Curie Individual Fellowship MCFI-2001-01645. Corresponding author: Eric Ghysels, Department of Economics, Gardner Hall, CB 3305, University of North Carolina at Chapel Hill, Chapel Hill, NC 27599-3305, Phone: (919) 966-5325, Fax (919) 966-4986. + Department of Economics, University of Cyprus, email: elena.andreou@ucy.ac.cy # Department of Economics, University of North Carolina and CIRANO, email: eghysels@unc.edu 1

We investigate how the benefits of international portfolio diversification differ across countries from the perspective of a local investor. We find that the benefits of investing abroad are largest for investors in developing countries, including when controlling for currency effects. Most of the benefits are obtained from investing outside the region of the home country. These global diversification benefits remain large when controlling for short-sales constraints in developing stock markets. In addition, the gains from international portfolio diversification appear to be largest for countries with high country risk. Other differences across countries, such as size of the stock market, size of the banking sector, and trade openness do not explain differences in the gains from international portfolio diversification beyond this first-order effect of the level of country risk. In addition to this cross-sectional evidence, we also provide evidence that diversification benefits vary over time as country risk changes. Given the decrease in country risk for most countries in our sample, this implies that diversification benefits have decreased over the period 1985 to 2002. JEL classification: G11

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We study the long-run and short-run dynamics between stock prices and exchange rates and the channels through which exogenous shocks impact on these markets through the use of cointegration methodology and multivariate Granger causality tests. We apply the analysis to a group of Pacific Basin countries over the period 1980 to 1998. The evidence suggests that stock and foreign exchange markets are positively related and that the US stock market acts as a conduit for these links. Furthermore, these links are not found to be determined by foreign exchange restrictions. Finally, through the application of recursive estimation the evidence shows that the financial crisis had a temporary effect on the long-run comovement of these markets.

The authors would like to thank participants in seminars at the Atlanta Finance Forum,

Financial account liberalizations since the second half of the 1980s paved way for the burgeoning literature that investigates foreign exchange market efficiency in emerg-ing markets via testing for the uncovered interest parity (UIP) condition. This paper provides a broad and critical survey on this recent literature as well as a general under-standing on the topic through reviewing the related literature on developed economies where recent methodological advances in time series econometrics have provided fa-vorable results, questioning the previously documented UIP puzzle. The literature on emerging markets suggests that these countries deserve a special treatment by taking into account the existence of additional types of risk premia, high inflation episodes, financial contagion, peso problem, simultaneity problem, asymmetricity, and the deter-mination of de facto structural breaks.