This paper conducts a theoretical and empirical investigation of the pricing (and portfolio) implications of investment barriers in the context of international capital markets. The postulated market structure-labelled "mildly segmented"-leads to the existence of "super" risk premiums for a subset of securities and to a breakdown of the standard separation result. The empirical study uses an extended data base including LDC markets and provides tentative support for the mild segmentation hypothesis. THE QUESTION AS TO whether the international capital market is integrated or segmented appears particularly elusive. Indeed, the difficulties surrounding this important issue abound, as was made vividly clear by Solnik [20].At the risk of tackling too ambitious a task, we undertake here to build a model and develop an empirical methodology to provide at least a partial answer to the segmentation-integration issue. To do so, we follow one of Solnik's recommendations [20, p. 505]:The efficient way to test for segmentation would seem to be to specify the type of imperfection which might create it and study its specific impact on portfolio optimality and asset pricing. * Errunza is from McGill University and Losq is from McGill University and ESSEC, France. The authors wish to thank the International Finance Corporation, Washington, D.C. for funding the development of the LDC securities data bank. Research assistance of Prasad Padmanabhan and insightful comments of James Bicksler, Bernard Dumas, Dennis Logue, Lemma Senbet, Rene Stulz, Alex Whitmore, and Morty Yalovsky are greatly acknowledged. Financial support was provided by SSHRC and Faculty of Management, McGill University. l By way of contrast, such an explicit representation of the risk-return tradeoff is generally missing in most of the well-known models of market segmentation. For example, in a recent paper on international asset pricing with barriers to entry, Stulz [24] fails to specify the risk-return tradeoff for at least one class of assets (those which are not traded by all investors). As for the oft cited paper of Adler and Dumas [1], the purpose is not really to characterize the equilibrium relationship between 105 106 The Journal of Finance command a super risk premium that is proportional to the conditional market risk. 2. The model lends itself to the analysis of a continuum of market structures, with the two polar cases corresponding to complete (one-way) segmentation and complete integration, respectively. Although there exist a number of papers dealing with the segmentation-integration issue,2 few accommodate intermediate-and more realistic-structures where the markets are neither completely segmented nor completely integrated. The paradigm which follows was designed to deal with this more realistic problem, and thus follows the lead of Black [3] and, more specifically, Stulz [24].3 3. The kind of imperfection which constitutes the source of segmentation in the model appears quite prevalent in the international arena.4 Indeed, accessto the capital ma...

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International asset pricing models suggest that barriers to portfolio flows and availability of market substitutes affect the degree and time variation of world market integration. We use GARCH-in-mean methodology to assess the evolution in market integration for eight emerging markets over the period 1977–2000. Our results suggest that while local risk is still a relevant factor in explaining time variation of emerging market returns, none of the countries appear to be completely segmented. We find that there are substantial crossmarket differences in the degree of integration. The evolution toward more integrated financial markets is apparent although at times we do observe reversals. In addition, we provide clear evidence on the impropriety of directly using correlations of market-wide index returns as a measure of market integration. Finally, financial market development and financial liberalization policies play important roles in integrating emerging markets.

Quantifying the evolution of security co-movements is critical for asset pricing and portfolio allocation, hence we investigate patterns and trends in correlations and tail dependence for developed markets (DMs) and emerging markets (EMs). We use the standard DCC and DECO correlation models, and we also develop a nonstationary DECO model as well as a novel dynamic skewed t-copula to allow for dynamic and asymmetric tail dependence. We show that it is possible to characterize co-movements for many countries simultaneously. We …nd that correlations have signi…cantly trended upward for both DMs and EMs, but correlations between EMs are much lower than between DMs. Tail dependence has also increased but its level is still very low for EMs as compared to DMs. Thus, while the correlation patterns suggest that the diversi…cation potential of DMs has reduced drastically over time, our …ndings suggest that EMs o¤er signi…cant diversi…cation bene…ts, especially during large market moves. JEL Classi…cation: G12This section outlines the various models we use to capture dynamic dependence across equity markets. We describe how the dynamic conditional correlation model of Engle (2002) and Tse and Tsui (2002) can be implemented simultaneously on many assets. 5

We examine whether portfolios of domestically traded securities can mimic foreign indices so that investment in assets that trade only abroad is not necessary to exhaust the gains from international diversification. We use monthly data from 1976 to 1993 for seven developed and nine emerging markets. Return correlations, mean-variance spanning, and Sharpe ratio test results provide strong evidence that gains beyond those attainable through home-made diversification have become statistically and economically insignificant. Finally, we show that the incremental gains from international diversification beyond home-made diversification portfolios have diminished over time in a way consistent with changes in investment barriers.

tion of the Japanese nationals w a s normal t o t h e i r s t a t u s as expatriates i n a foreign country. However , the hypothesized difference could be discerned between the Americans and t h e Japanese-Americans .

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Reform of local capital markets and relaxation of capital controls to attract foreign portfolio investments (FPIs) has become an integral part of development strategy. The proximity of market openings and large, sudden shifts in international capital flows gave credence to the notion that the liberalization was the primary culprit in precipitating the recent Asian crisis. Hence, this paper reassesses the benefits and costs of FPIs from the perspective of the recipients. Specifically, it discusses the various FPI contributions and presents empirical evidence regarding the relationship between FPIs and market development, degree of capital market integration, cost of capital, cross-market correlation and market volatility. It is clear that the evidence on benefits of FPIs is strong, whereas the policy concerns regarding resource mobilization, market comovements, contagion, and volatility are largely unwarranted. The authors make some policy suggestions regarding preconditions for capital market openings, market regulation, and liberalization sequencing.