Report On

Impact Financial Integration on Stock Market

By: Shubham Tyagi PGP20101279

Concept and financial dimensions Market Integration The integration of financial markets involves a complex interaction of several factors such as policy initiatives, structure and growth of financial intermediaries markets, organic links between market participants and the preference of savers and investors in financial instruments .Although the assessment of financial market integration can be useful in view of the heterogeneity of markets, the dimensions of integration, measurement problems and perceived benefits and risks of integration to maintain.

Heterogeneity of markets Various financial market segments are not uniform, since in a variety of instruments that differ in terms of liquidity risk and trade. First, some market segments are national, while others are international in character, depending on where financial transactions occur between participants within the geographic boundaries of a country or across the border.In general, money and credit are the market segments with the participation of banks and other financial institutions within the limits of a country's national character.On the other hand, the currency markets Crossl crossborder transactions and securities markets which secur and Ings is events ionicipat foreign institutional investors in nat ional in nature. Second, financial markets differ in the depth and liquidity.Thus money market instruments are more liquid, while bonds are less liquid capital markets.Third, financial markets

differ in terms of the economic nature of instruments catering vers economic needs. For example, a distinction between savings, investments, loans and derivatives are made.Markets Fourth, financial differentiated in terms of risk profile of instruments such as government bonds, for which no default risk and credit risk, and corporate bonds, which are relatively risky nature.Integration of market segments, reflecting an attitude of investors toward risk and the trade-off between risk and return of assets.Fifth, the market participants in different financial markets be different, such as banks, non - financial institutions, including mutual funds, insurance companies, mortgage banks and specialized financial institutions in the long term.The integration of financial markets at a theoretical level it has been postulated in several respects.More popular economic principles of financial market integration is the law of one price, interest rates in the long run, the conditions of parity as the parity of purchasing power, financial stability (Trichet, 2005).Fifth, the integration of markets, innovation and cost effective governing body and therefore improve access to financial services Members of the public, institutions and firms (Giannetti et al., 2002).Markets sixth, integrated financial, prompting market discipline and efficiency information.Seventh, promote market integration, the introduction of modern technologies and payment systems to achieve low-cost banking services.

Measures of financial integration The progress of local integration, regional and global financial markets can be measured with a number of approaches.Institutional measures / regulatory, quantity and price measures: These measures are divided into three categories.From a political perspective, could include specific indicators of financial integration in the de jure and de facto are classified Measures.The existence of legal restrictions on trade and capital flows across the border as well as market segments are the most used indicators in law.However, these indicators have several shortcomings such restrictions can not be binding or not met, as capital flows otherwise not exist.You can not cover a specific aspect of all possible obstacles to financial integration. Moreover, in practice, de jure indicators dichotomously assuming the existence or absence of limitations does not reveal the actual degree of openness of countries, capital flows. In fact, the indicators for the integration of financial markets are not habitually based ice pr i or quantities.The base price measures most commonly used to test the convergence of price adjustment and market segments are inter-market spreads, correlations between different interest rates, tests of common trend in the ter m st r ucture of interest rates and electricity transmission volat ili. From a policy perspective, the interest rate differential between interest rates and short-term benchmark short-term market-based instruments, on the one hand, and various other market interest rates in the Across the measurement of price convergence and effectiveness of the policy used.Price also indoor and outdoor measures of interest rate parity, as well as asset price correlations

between countries. However, there are serious practical problems in using prices global or regional financial integration, to measure, particularly in emerging markets. This is because prices may move together because of a common external factor or similar macroeconomic fundamentals and not by market integration. Besides the differences in rates of monetary, credit and liquidity are influenced by what means different price movements even when there is a high degree of integration of financial markets

Benefits of financial integration Costs and benefits of integration of financial markets from the perspective of states, individuals, corporations and financial institutions will be considered.In the hierarchy is the integration of national financial markets, followed by global and regional integration (Sundarajan et al., 2003).In contrast to international integration, the benefits of financial market integration is difficult to deny.Financial markets are an important pillar of the market economy and to mobilize savings, spreading risk, absorb external financial shocks, promote good governance through market incentives and contribute to a more stable funding investment and therefore higher economic growth, lower volatility and greater macroeconomic stability (Mohan, 2005).The development of local financial markets reduces the risks of excessive reliance on foreign capital are linked, including currency mismatches and Matura i ty (Prasad et al., 2003).National integration provides an effective means for the transmission of policy impulses (Ptursson, 2001; Bhoi and Dhal, 1998).The benefits of global integration depends on the size, composition and quality of capital

flows. Global financial integration and indirect benefits and indirect involvesdirect (Prasad et al. 2006).Analytical arguments for financial openness on ma circle into consideration how the benefits of international risk sharing for consumption smoothing, connected to the positive impact of capital flows on domestic investment and growth, macroeconomic discipline and efficiencyimproved and more stable domestic financial system with financial openness (Agenor, 2001).international integration of financial markets could have a positive impact on total factor productivity (Levine, 2001). Financial openness, depth and breadth of financial markets and lead to an increase in the efficiency of credit intermediation process by lowering costs and high profits in monopoly markets and cartelized involved, which increases the cost of investment and improving resource allocation (Levine, 1996; Caprio and Honhan, 1999). Empirical research on international integration offer mixed perspectives on the benefits of the integration of financial markets. The accumulated growth in emerging markets, the risks and benefits of financial integration, without China and India seem less dramatic than in the control globalization (Prasad et al., 2006) perceived. The integration of financial markets also poses some risks and costs.A major risk is the contagion that was the case of the crisis in East Asia.There are two channels through which the contagion is working normally. One of them, the current channel, the potential "ripple effects" through real images of the participants, referring to other segments.Two, the information channel, which refers contagious withdrawals from the lack of accurate and timely. Greater national and international integration emphasizes the danger of contagion from problems in one market Segment are likely to be transferred to other markets the potential for systemic instability. In the context of

globalization, the potential costs of high concentration of capital flows, poor distribution of the minimum f thei r growth can prevent aggravating the effects EF domestic distortions, the loss of macroeconomic stability, the cyclical nature capital flows and short-term risk of abrupt changes, a high degree of volatility of capital flows, and partly to protect sources domino effects and the risks associated with foreign bank penetration (Dadush, Dasgupta and Ratha, 2000) connected.Most studies conclude that FDI tends to be less volatile than other forms of capital (Chuh et al, 1996;. Brewer and Nollen, 2000, Sarno and Taylor, 1999).The volatility of capital flows results in the exchange rate instability (in the flexible exchange rate) or large fluctuations observed in official reserves (under a regime of pegged exchange rate) and sometimes the crises in East Asia crisis.For example, the volatility of nominal exchange rate hampers the expansion of exports if the hedging techniques are not available exporters.Large capital inflows could also lead to rapid monetary expansion (due to the difficulty and expense of conducting aggressive sterilization policy), inflationary pressures (due to the effect of capital flows on domestic spending), the appreciation of real exchange rate and lead The expansion of the current account deficit. Measures, integration of financial markets in India In general, the integration of financial markets in India has been facilitated by various means in the form of free pricing, expansion of the basis of market share, introducing new instruments and improvements in pay and infrastructure systems of settlements. Freedom of prices The price of free financial markets has been facilitated by several Measures.These include the freedom to choose the banks, Interest rates on deposits and loans, the withdrawal of up to 10 Percent federal funds rate set by banks in India ' Association in 1989, the replacement of administered interest rates

of government bonds through an auction system, the abolition of Ad hoc system of Treasury bills in April 1997 and the replacement by the system of Ways and Means Advances (WMA), effective the first in April 1997, change in the exchange rate regime of a single currency to a fixed exchange rate determined by the market fluctuating exchange rate, the gradual liberalization of capital movements Account in accordance with the recommendations of the Commission Capital account (Chairman: Shri SS Tarapore) and freedom Banks to determine interest (up to a ceiling) and Duration of foreign currency non-resident (FCNR) Deposit (no more than three years), and derivatives Products to cover risks. In the capital market, capital issues (Control) Act was passed in 1947 repealed.The introduction of the process of bookbuilding in New issue market to strengthen the price discovery process. Broader participation Increased presence of foreign banks in line with India Commitment to the World Trade Organization under the GATS, increasing domestic and international links, exposed, apart from increasing competition. First, was to participate in the call market gradually expanded by the inclusion of non-banks as non-bank financial institutions finance companies, primary dealers / satellite, investment funds and

Companies (through primary dealers).The process of Transformation of the call money market a pure inter-bank Market, which began in May 2001, in final August 2005. Foreign Institutional Investors (FII) were allowed to participate in the Indian stock market and the implementation of 100 per cent debt funds invest in government (Central and Regional Library) values in both primary and secondary market.This provided an important impetus integration of national markets to international markets. The connection between the local exchange market and overseas market (vertical integration) was facilitated by Banks may / dealers (ADS) to borrow and invest Foreign funds (within certain limits), and pay in foreign currency Foreign Exchange for companies in India are for productive purposes the option to save on interest costs and exchange Risk. Exporters also have the ability to replace a rupee loan Credit in foreign currency. Indian companies were allowed to get outside resources by American Depository Receipts / Global Ministerial Environment Forum (ADRs / GDRs) Currency Convertible Bonds (FCCBs) and external commercial borrowing (ECB), which facilitates the integration domestic capital market with international capital market.The Reserve Bank allows two-way fungibility of ADRs / GDRs in February 2002. Companies were allowed to carry out active coverage Operations through the use of the cancellation and rebooking of

forward Contracts, forward contracts based reserve in the past Performance, including currency options and forwards, and To manage access to foreign currency long-term rupee swap Claims arising from external commercial borrowing. Integration of the credit market and the stock market reinforced by the application of capital standards and regulations so that the public banks to raise equity capital Market up to 49 percent of its paid capital. New Instruments Repurchase agreements (repos) was introduced as a tool for setting short-term liquidity.The adjustment of liquidity (LAF) is open to banks and primary dealers. The LAF is committed to a tool for managing liquidity and signaling devices interest rates in the overnight rate. Several new financial Instruments such as certificates of inter-bank participation (1988), Certificates of Deposit (June 1989), commercial paper (January Were introduced in 1990) and repos (December 1992). Secured Obligation bonds and loans (CBLO) and the repo market have emerged as a money market instruments. introduced new instruments to auction 364 days In 182 days, 91 days and 14 days treasury bills, zero coupon bonds and the Government of India dated securities. In the long term Segment, floating rate bonds (FRB) compared with 364 Day Treasury bill yields and 10-year bond with embedded call and put options exercisable as of 5 years from the date of Topic were introduced. Derivatives such as interest rate agreements and Interest rates have been introduced in July 1999

Banks, institutions and hedge the risks of interest rates, the PDS. A rupee-foreign Foreign exchange market has developed.Foreign AD Foreign exchange market were allowed to use currency options Interest rates and currency swaps, caps / collars and interest rate Agreements (FRA) in foreign exchange markets Market, thereby deepening the market and allowing participants to diversify their risk. Institutional measures Institutions such as Discount and Finance House of India (DFHI), Securities Trading Corporation of India (STCI) and PD were allowed to participate in more than one market, so Strengthening ties market position. The Clearing Corporation of India Ltd. (CCIL) was set up to central counterparty for all transactions with the outside Instead, government securities and other debt instruments passes through it, and to ensure settlement. Technology, infrastructure Payment and Settlement The system of delivery versus payment (DVP), which agreed System Engineer Deal (NDS) and the subsequent mind, the widespread Negotiated Treatment System - order matching (NDS-OM) Trading module and real-time gross settlement system (RTGS) has brought enormous benefits in terms of facilitating Transactions and improve the process of liquidation, the the integration of markets have contributed. In the stock market, the floor-based open trading floor System has been replaced by electronic trading system at all Exchanges.

Stock market integration As noted above, the stock market has been relatively low and denial sively cut ive Relat ions with other market segments (Table 8.2).The low correlation with stock market risk-free instruments is indicative of a higher volatility of stock returns and the existence of large risk premium for stocks. The large risk premium occurs when the movements of stock prices not be rationalized with the standard models of intertemporal optimization of macroeconomic fundamentals as the former savings and ions (Mehra and Prescott, 19 85). This could be due to the different parties involved in stocks and other financial markets. For example, joint participation of banks in the money ensures that the government, the foreign exchange and credit markets rather high correlation between these segments. The exposure of banks, capital market such Tues remains limited due to restrictions by regulation. One of the main reasons for rising stock prices could be due to mismatches of supply and demand for equities. In fact, most of the promoter action by institutional investors, held as in Chapter VII. The offer of securities for retail investors could be p ossibly behind their claim behind. Stock prices, however, have a relatively high correlation with the rate of interest than other market interest rates. This is because portfolio investors, especially FII allowed its commitment to cover the foreign exchange market through the futures market. The integration and market stability

The process of integration of financial markets may be smooth or volatile depending on the risks associated with various instruments.If the integration of financial markets occurs in a

smooth manner, promotes efficiency in resource allocation and financial system stability.By contrast, integration-induced volatility to speculation and undermines the competitive process of prices, with adverse consequences for the allocation of resources.In the Indian context, empirical evidence shows that greater integration of financial centers in the market segments with lower volatility of interest rates was accompanied. Block exchange, various segments of financial markets in general, much less seen the volatility (measured by standard deviation) during April 2000-March 2007 than in the previous period April 1993March 2000. The cross-sectional volatility of market interest rates have also declined, reflecting on the convergence of interests through effective management of liquidity and increase the depth of financial markets.

Conceptual problem A well-developed financial sector has the following functions: Promotes total savings of the economy through the provision of alternative instruments; Resources are effectively allocated to sectors and

It provides an effective means for the transmission of policy Vegetables, if financial markets are competitive, efficient and integrated.

A typical competitive financial market has the following characteristics: A large number of buyers and sellers of financial products should be The product price is determined by market forces Supply and demand; There should be a secondary market for the instrument; Sales of instruments in primary and secondary markets must be quite large, and Agencies in the process of mediation between buyers and sellers are involved, if mediation services are distributed to a minimum. Impact of financial integration One of the consequences of integration is that the market determines the price of goods or assets in an efficient and equitable. The degree of integration also show if there efficiency gains from liberalization. The integration of financial markets also induced changes in the basic economic structure and the operating environment for political affairs, and households. This change may also make it difficult and often confusing, the behavior in the transition to a market economy, which is very necessary to determine if the

context of the liberalization of capital movements. The liberalization of capital movements in most countries due to concerns that the international integration of financial markets stimulate capital flows that lead to the appreciation of real exchange rate and thus reduce their international competitiveness (Dornbusch and Park, 1994) hampered. Another aspect of the policy from the analysis of financial markets is the growing importance of foreign interests in the formation of domestic prices and foreign influence in the local economy in general. This in turn can change the synchronization of business cycles across countries. The financial asset prices play an important role in the economy, affecting the marginal evaluations and decisions, and because they contain the expectations of the future.Converge that financial asset prices in individual countries, where some clashes, which had previously been customary idiosyncratic impulses and must work together to produce localand foreign economies. The economy can respond to the same stimuli, but the mechanism of generation of pulses that change in their internationalization. Financial integration therefore can mean greater integration of the real economy (Brouwer, 1999) The degree of international integration of markets strongly influenced the behavior of exchange rates and interest rates in different countries, which in turn have a significant impact on the extent to which national monetary authorities can chart an independent monetary policy (Agenor, 2001). There is little controversy over the proposition that more integrated international markets for goods, capital and currency markets, the more limited framework for achieving an independent national monetary policy. For example, when to move goods and capital in order to bridge the gap between prices and interest rates in different countries, domestic monetary authorities have no control over their real exchange rates and interest rates compared to those of other countries, limiting the impact of their stabilization policies. Therefore, it is necessary to fully consider the potential

effects of international integration of markets .