Measures of Financial Integration

AuthorMartin Schindler
Pages1-3

Page 1

Measures of Financial Integration

Global financial integration, as measured by the magnitude of cross-border financial asset holdings, has grown exponentially in recent years. While it can benefit economies through improved access to capital and better risk diversification, it may also facilitate the transmission of adverse shocks across countries. Better understanding the relative costs and benefits of financial globalization is important for policy analysis: should policymakers impose restrictions on cross-Page 2 border capital flows or should they undertake policies to attract more flows? Central to empirical research investigating this and related questions is the measurement of financial integration.

Over the past several years, an increasing number of such measures have been made available, including de jure measures, aiming to reflect the extent to which countries impose legal restrictions on cross-border financial flows, and outcome-based de facto measures, aiming to capture a country's actual degree of financial integration. For the purpose of policy analysis, de jure measures, which are under policymakers' direct control, are more relevant, while in other applications, de facto measures may be more appropriate; in still other situations, both may be necessary, for example, if the research question centers on the effectiveness of capital controls in stemming de facto outcomes.

Most de jure measures rely on information contained in the IMF's Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER). Until 1995, the AREAER summarized a country's openness to capital flows using a binary dummy variable. Since 1995, the AREAER has provided additional information on capital account restrictions in several subcategories. The structural break in the AREAER's format confronts researchers with a trade-off between sample coverage and detail.

The binary AREAER indicator provides the largest sample coverage, with a (unbalanced) panel starting in 1966 and covering 184 countries. Grilli and Milesi-Ferretti (1995) were among the first to use this indicator. However, the binary index only crudely approximates a country's degree of capital account openness and provides no information on the composition of capital controls.

The AREAER reported three additional binary variables: on current account openness; on export proceeds' surrender requirements; and on multiple...

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