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No. 565: Measuring Regional Market Integration by Dynamic Factor Error Correction Model (DF-ECM) Approach - The Case of Developing Asia

Duo Qin , Queen Mary, University of London
Marie Anne Cagas , University of the Philippines
Geoffrey Ducanes , University of the Philippines
Nedelyn Magtibay-Ramos , Asian Development Bank
Pilipinas F. Quising , Asian Development Bank

September 1, 2006

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Abstract

This paper examines empirically the dynamic process of regional market integration for twelve individual Asian economies by a new modeling approach, which combines DF with ECM. This new approach enables us to obtain latent regional dynamic factors, which correspond well with the 'foreign' parity variables in theory when market is imperfectly integrated and which act, in explaining domestic short-run price adjustments, as leading-indicators in an error-correction form. The power of the DF-ECM approach is illustrated in its application to measuring market integration in the developing Asian region using monthly data of the past decade.

J.E.L classification codes: F31, F40, F15, C22, C33

Keywords:Law of one price, Market integration, Dynamic factor, Error-correction model

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