the internationalisation of stock markets and the abolition of u k exchange control this paper aims to assess the impact of the abolition of u k exchange control on the degre of integration of u k and overseas stock markets using cointegration techniques we find that although there is no significant increase in the correlation of short run stock market returns for the united kingdom and certain overseas markets post 1979 there does appear to be a marked increase in the degree to which these markets move together in the long run after this date there appears to be no long run gain from diversification since cointegration of two variables implies that at least one of them can be used to help forecast the other our findings also imply the inefficiency of a number of stock markets

carbon prices and fuel switching a quasi experiment in electricity markets within the pennsylvania new jersey maryland electricity market delaware and maryland participate in the regional greenhouse gas initiative rggi but other states do not providing a quasi experimental setting to study the rggi program using a difference in difference framework we find that overall the rggi program led to 6 22 million short tons of co2 reduction per year in delaware and maryland or about 19 10 of the average total potential annual emissions in these two states from 2009 to 2013 counterintuitively however the reduction is mainly achieved through reduction of coal inputs and emission leakage instead of fuel switching from coal to natural gas or from fossil fuel coal and natural gas to non fossil fuel

inefficient credit booms this paper studies the welfare properties of competitive equilibria in an economy with financial frictions hit by aggregate shocks in particular it shows that competitive financial contracts can result in excessive borrowing ex ante and excessive volatility ex post even though from a first best perspective the equilibrium always displays under borrowing from a second best point of view excessive borrowing can arise the inefficiency is due to the combination of limited commitment in financial contracts and the fact that asset prices are determined in a spot market this generates a pecuniary externality that is not internalized in private contracts the model provides a framework to evaluate preventive policies which can be used during a credit boom to reduce the expected costs of a financial crisis copyright 2008 wiley blackwell

trilemma stability and international macroeconomic archetypes this paper uses the simple geometry of the classic open economy trilemma to introduce a new gauge of the stability of international macroeconomic arrangements the new stability gauge reflects the simultaneity of a country s choices of exchange rate fixity financial openness and monetary sovereignty so the new gauge is bounded and correspondingly non gaussian we use the new stability gauge in nonlinear panel estimates to examine the post bretton woods period and we find that trilemma policy stability is linked to official holdings of foreign exchange reserves in low income countries we also find that the combination of fixed exchange rates and financial market openness is the most stable arrangement within the trilemma and middle income countries have less stable trilemma arrangements than either low or high income countries the paper also characterizes international macroeconomic arrangements in terms of their semblance to definitive policy archetypes and it uses the trilemma constraint to provide a new gauge of monetary sovereignty

on the effects of monetary policy in vietnam evidence from a trilemma analysis during and after the 2008 2009 global financial crisis the growth cycle of vietnam s economy has shifted from an average annual growth rate of 7 8 to an average annual growth rate of 5 6 with a high level of macroeconomic instability and uncertainty from 2009 till 2016 related studies have speculated that the operations of monetary policies during this period were not effective in recovering the economic growth and stabilizing the overall price level and total output level this paper provides the first empirical examination of this speculation using the trilemma framework our empirical results show that the state bank of vietnam has had adopted a set of policies aiming at maintaining exchange rate stability and interest rate independence while easing the restrictions on capital inflows the combination of these three monetary policy approaches is found to violate the rule of trilemma consequently exchange rate and interest rate policies became less effective and failed to stabilize the economy in response to the global economic recession

comovements in national stock market returns evidence of predictability but not cointegration abstract this paper is a response to the literature that tests for cointegration between national stock market indices it argues that apparent findings of cointegration in other studies may often be due to the use of asymptotic rather than small sample critical values in fact economic theory suggests that cointegration is unlikely to be observed in efficient markets however this paper finds evidence for the predictability of relative returns and the existence of a winner loser effect across 16 national equity markets a conclusion is that national stock market indices include a common world component and two country specific components one permanent and one transitory

changes in the comovement of european equity markets this paper investigates the impact that the removal of exchange controls within major european economies has had on the interdependence of european equity markets for five years prior to the removal of exchange controls and five years following their removal we use impulse responses and variance decompositions from vector autoregressions to illustrate that european equity markets have become substantially more integrated after the removal of exchange controls we undertake further tests that demonstrate that even if we allow for parallel macroeconomic harmonization the removal of exchange controls has been a major cause of increased equity market integration within europe

mean variance portfolio selection of cointegrated assets abstract this paper considers the continuous time mean variance portfolio selection problem in a financial market in which asset prices are cointegrated the asset price dynamics are then postulated as the diffusion limit of the corresponding discrete time error correction model of cointegrated time series the problem is completely solved in the sense that solutions of the continuous time portfolio policy and the efficient frontier are obtained as explicit and closed form formulas the analytical results are applied to pairs trading using cointegration techniques numerical examples show that identifying a cointegrated pair with a high mean reversion rate can generate significant statistical arbitrage profits once the current state of the economy sufficiently departs from the long term equilibrium we propose an index to simultaneously measure the departure level of a cointegrated pair from equilibrium and the mean reversion speed based on the mean variance paradigm an empirical example is given to illustrate the use of the theory in practice

what can we learn from the grand policy experiment lessons from so2 allowance trading stable url http links jstor org sici sici 0895 3309 28199822 2912 3a3 3c69 3awcwlft 3e2 0 co 3b2 tthe journal of economic perspectives is currently published by american economic association your use of the jstor archive indicates your acceptance of jstor s terms and conditions of use available athttp www jstor org about terms html jstor s terms and conditions of use provides in part that unless you have obtainedprior permission you may not download an entire issue of a journal or multiple copies of articles and you may use content inthe jstor archive only for your personal non commercial use please contact the publisher regarding any further use of this work publisher contact information may be obtained athttp www jstor org journals aea html each copy of any part of a jstor transmission must contain the same copyright notice that appears on the screen or printedpage of such transmission the jstor archive is a trusted digital repository providing for long term preservation and access to leading academicjournals and scholarly literature from around the world the archive is supported by libraries scholarly societies publishers and foundations it is an initiative of jstor a not for profit organization with a mission to help the scholarly community takeadvantage of advances in technology for more information regarding jstor please contact support jstor org http www jstor orgtue jun 26 16 25 17 2007

analysis of long run benefits from international equity diversification between taiwan and its major european trading partners an empirical note this paper employs four cointegration test approaches po hi jj and kss to test for pairwise long run equilibrium relationships between taiwan s stock price index and each of the stock price indexes of four european markets french german dutch and british stock markets the results from these four tests are robust and clearly consistent in suggesting that the taiwan stock market is not pairwise cointegrated with the four european stock markets this provides strong evidence that there exist long run benefits for taiwan investors diversifying in the equity markets of taiwan s major european trading partners france germany holland and the uk over the sample period considered from 6 january 1998 to 30 may 2002 these findings could be valuable to taiwan individual investors and financial institutions holding long run investment portfolios in the equity markets of france germany holland and the uk

exchange controls and european stock market integration this paper examines the impact on stock price predictability that the removal of exchange controls had on major european countries during the late 1970s and 1980s it is found that for germany switzerland and france the removal of exchange controls led to an increase in the interdependence between these and other markets in contrast there is little evidence of an increase in interdependence for the uk and italy

monetary targeting in the netherlands an application of cointegration tests there are two criteria to choose an intermediate variable for monetary targeting first the money demand function needs to be stable and second the monetary authorities should be able to control the target variable given the available instruments in this paper we examine whether m1 and m2 in the netherlands fulfil the first requirement i e we investigate whether a stable relationship exists between these monetary variables and key macroeconomic variables co integration techniques are used which are very well suited for this purpose monetary policy in the netherlands has been directed towards the growth rate of broad money m2 the present findings do not suport the choice of m2 as an intermediate target for monetary policy in the netherlands a stable long term relationship between m2 and real nnp and long and short term interest rates does not exist the results for m1 are considerbly better though not favourable at all scores the estimated moeny demand function for m1 is a good indicator for m

classifying exchange rate regimes deeds vs words abstract most of the empirical literature on exchange rate regimes uses the imf de jure classification based on the regime announced by the governments despite the recognized inconsistencies between reported and actual policies in many cases to address this problem we construct a de facto classification based on data on exchange rates and international reserves from all imf reporting countries over the period 1974 2000 which we believe provides a meaningful alternative for future empirical work on the topic the classification sheds new light on several stylized facts previously reported in the literature in particular we find that the de facto pegs have remained stable throughout the last decade although an increasing number of them shy away from an explicit commitment to a fixed regime hidden pegs we confirm the hollowing out hypothesis but show that it does not apply to countries with limited access to capital markets we also find that pure floats are associated with only relatively minor nominal exchange rate volatility and that the recent increase in the number of de jure floats goes hand in hand with an increase in the number of de facto dirty floats fear of floating

long run relationships between international stock prices further evidence from fractional cointegration tests the recent empirical literature supports the view that most of the international stock prices are not pairwise cointegrated however by using fractional cointegration techniques this paper shows that france germany hong kong and japan stock prices indices are pairwise fractionally cointegrated with us stock prices equilibrium errors are mean reverting with half life lying between 2 and 12 days it is worthwhile noting that emerging markets like brazil and argentina are not pairwise cointegrated with the us stock market these new results have important implications for asset pricing and international portfolio strategy

cointegration market integration and market efficiency abstract this paper uses a standard dynamic general equilibrium asset pricing model to study the relationship among the concepts of efficient markets integrated markets and cointegrated prices within this setting we show that these concepts are independent of one another and any zero one two or three of these characteristics can emerge in equilibrium depending upon taste endowment and technology parameters in particular the results of tests of cointegration among asset prices have no implications about market efficiency or market integration without additional restrictions on the economy or economies

an empirical study of the asymmetric cointegration relationships among the chinese stock markets the enders and siklos asymmetric cointegration test is employed to examine the long run asymmetric equilibrium relationships between the chinese shanghai and shenzhen stock markets three samples are adopted which are the whole sample october 1992 to september 2002 the first subsample before b shares were opened up to the chinese public october 1992 to february 2001 and the second subsample after b shares were opened up february 2001 to september 2002 the estimated results are as follows first when the conventional engle granger symmetric cointegration test is used only the a shares in shanghai and shenghen stock exchange market are cointegrated when using the whole sample and the first subsample however with the enders siklos m tar asymmetric cointegration test shenzhen a and b shares stock prices have an asymmetric cointegration relationship after b shares were open suggesting that openness increases the market efficiency furthermore the two a shares in shanghai and shenzhen stock exc

capital flow management measures what are they good for abstract are capital controls and macroprudential measures related to international exposures successful in achieving their objectives assessing their effectiveness is complicated by selection bias countries which change their capital flow management measures cfms often share specific characteristics and are responding to changes in variables that the cfms are intended to influence this paper addresses these challenges by using a propensity score matching methodology we also create a new database with detailed information on weekly changes in controls on capital inflows capital outflows and macroprudential measures related to international transactions from 2009 to 2011 for 60 countries results show that these macroprudential measures can significantly reduce some measures of financial fragility most cfms do not significantly affect other key targets however such as exchange rates capital flows interest rate differentials inflation equity indices and different volatilities one exception is that removing controls on capital outflows may reduce real exchange rate appreciation therefore certain cfms can be effective in accomplishing specific goals but most popular measures are not good for accomplishing their stated aims

integration vs segmentation in the canadian stock market this paper examines the issue of integration versus segmentation of the canadian equity market relative to a global north american market we compare the international and domestic versions of the capm and find that integration or the mean variance efficiency of the global market index is rejected by the data segmentation is the preferred model based on a maximum likelihood procedure correcting for thin trading we further divide the sample into securities that are interlisted in canada and the u s and those that are not integration is rejected for both groups which indicates that the source of segmentation can be traced to legal barriers based on the nationality of issuing firms empirical studies of international capital markets have left the issue of segmentation versus integration largely unresolved yet the question of national or international pricing of assets has crucial implications for financial decisions if national stock markets are segmented then international portfolios should display superior risk adjusted performance because some of the priced domestic systematic risk is diversifiable also with segmentation many irrelevance propositions for corporate financial strategy break down home firms face optimal hedging decisions as well as optimal foreign versus home borrowing decisions finally criteria for capital budgeting decisions will be quite different under national and international pricing the purpose of this paper is to shed some light on this integration versus segmentation question for the canadian equity market vis a vis a global north american market in this paper integration is defined2 as a situation where investors earn the same risk adjusted expected return on similar financial instruments in different national markets the key problem of course is the pricing

arbitrage cointegration and testing the unbiasedness hypothesis in financial markets we use a no arbitrage cost of carry asset pricing model to show that the existence of coin tegration between spot and forward futures prices depends on the time series properties of the cost of carry we argue that the conditions for cointegration are more likely to hold in currency markets than in commodity markets explaining many of the empirical results in the literature we also use this model to demonstrate why the forward rate forecast error the basis and the forward premium are serially correlated and to develop econometric tests ofthe unbiasedness hypothesis sometimes called the simple efficiency hypothesis in various financial markets the unbiasedness hypothesis is so prevalent in the finance liter ature that many tests for it have been developed we examine four of the common tests and and use our cointegration results to demonstrate why each of these tests should reject the null hypothesis of unbiasedness we find strong support for our hypothesis in the existing empirical literature

the financial cycle and macroeconomics what have we learnt abstract it is high time we rediscovered the role of the financial cycle in macroeconomics in the environment that has prevailed for at least three decades now it is not possible to understand business fluctuations and the corresponding analytical and policy challenges without understanding the financial cycle this calls for a rethink of modelling strategies and for significant adjustments to macroeconomic policies this essay highlights the stylised empirical features of the financial cycle conjectures as to what it may take to model it satisfactorily and considers its policy implications in the discussion of policy the essay pays special attention to the bust phase which is less well explored and raises much more controversial issues

a model of intertemporal emission trading banking and borrowing abstract this paper provides a general treatment of emission trading banking and borrowing in an intertemporal continuous time model using optimal control theory the decentralized behavior of firms is shown to lead to the least cost solution attainable under joint cost minimization explicit solutions for the time paths of emissions and permit prices are derived when firms are allowed to both bank and borrow and when firms are only allowed to bank emission permits the policy implications of emission banking and borrowing are discussed

on market integration and liberalisation method and application to ethiopia the article suggests further improvements in the methodology to analyse market integration it provides corrections to and methodological extensions of recent work in this journal it also presents a way of applying market integration techniques to the analysis of shocks such as market liberalisation and war the method is applied to the effects of liberalisation and the end of the civil war on food markets in ethiopia the conclusion is that liberalisation had important effects on the long run and short run integration of food markets

the structure of interdependence in international stock markets abstract this study investigates the dynamic structure of nine major stock markets using an error correction model and directed acyclic graphs dag the dag representation provides a structure of causality among these markets in contemporaneous time building on this contemporaneous structure and the estimated error correction model innovation accounting techniques are applied the results show that the japanese market is among the most highly exogenous and the canadian and french markets among the least exogenous in our nine market study the us market is highly influenced by its own historical innovations but it is also influenced by market innovations from the uk switzerland hong kong france and germany the us market is the only market that has a consistently strong impact on price movements in other major stock markets in the longer run

cointegration how short is the long run abstract when testing for cointegration and faced with short sample periods it is common for researchers to turn to more frequently sampled observations that is to move from annual to quarterly or monthly data in order to increase the number of observations we argue that such a gain in the degrees of freedom is more apparent than real essentially cointegration is a long run concept and hence requires long spans of data to give tests for cointegration much power rather than merely large numbers of observations using monte carlo simulations we demonstrate this for four popular tests for cointegration

emissions trading electricity restructuring and investment in pollution abatement this paper analyzes an emissions trading program that was introduced to reduce smog causing pollution from large stationary sources using variation in state level electricity industry restructuring activity i identify the effect of economic regulation on pollution permit market outcomes there are two main findings first deregulated plants in restructured electricity markets were less likely to adopt more capital intensive environmental compliance options as compared to regulated or publicly owned plants second as a consequence of heterogeneity in electricity market regulations a larger share of the permitted pollution is being emitted in states where air quality problems tend to be more severe jel l51 l94 l98 q53 q58 when the us federal government first began regulating major sources of air pollution in the 1960s the conventional approach to meeting air quality standards involved establishing maxi mum emissions rates or technology based standards for regulated stationary sources however economists have long maintained that an emissions permit market could more efficiently coor dinate pollution abatement activities provided a series of assumptions are met over the past few decades market based cap and trade cat approaches to regulating emissions from industrial point sources have become a centerpiece of environmental regulation in the united states in the theoretical first best permit market equilibrium the total social cost of meeting an emis sions cap is minimized each firm chooses a level of pollution abatement such that its marginal cost of reducing pollution is set equal to the social marginal benefit from emissions reduction in practice preexisting distortions in product markets that are subject to cat regulation may interfere with the emissions permit market s ability to operate efficiently this paper studies the effects of electricity market regulation on permit market outcomes in the context of a major us emissions trading program the nox budget program the recent wave of electricity industry restructuring in the united states has resulted in significant interstate variation in economic regulation consequently facilities in the same cat program face very different economic regu lation and investment incentives in their respective electricity markets whereas rate base regu lated plants are guaranteed to earn a rate of return on prudent investments in pollution abatement equipment deregulated plants operating in restructured electricity markets are offered no such

the market for sulfur dioxide emissions the 1990 clean air act amendments initiated the first large scale use of the tradable permit approach to pollution control the theoretical case for this approach rests on the assumption of an efficient market for emission rights the authors empirical analysis shows that the emission rights market created by the 1990 amendments had become reasonably efficient by mid 1994 they also show that the auctions specified in the amendments to jump start trading had become a small part of the overall market finally the authors demonstrate that the strategic bidding behavior discussed in the literature has had no effect on market prices copyright 1998 by american economic association

mean variance asset liability management cointegrated assets and insurance liability abstract the cointegration of major financial markets around the globe is well evidenced with strong empirical support this paper considers the continuous time mean variance mv asset liability management alm problem for an insurer investing in an incomplete financial market with cointegrated assets the number of trading assets is allowed to be less than the number of brownian motions spanning the market the insurer also faces the risk of paying uncertain insurance claims during the investment period we assume that the cointegration market follows the diffusion limit of the error correction model for cointegrated time series using the markowitz 1952 mv portfolio criterion we consider the insurer s problem of minimizing variance in the terminal wealth given an expected terminal wealth subject to interim random liability payments following a compound poisson process we generalize the technique developed by lim 2005 to tackle this problem the particular structure of cointegration enables us to solve the alm problem completely in the sense that the solutions of the continuous time portfolio policy and efficient frontier are obtained as explicit and closed form formulas

water for life the impact of the privatization of water services on child mortality while most countries are committed to increasing access to safe water and thereby reducing child mortality there is little consensus on how to actually improve water services one important proposal under discussion is whether to privatize water provision in the 1990s argentina embarked on one of the largest privatization campaigns in the world including the privatization of local water companies covering approximately 30 percent of the country s municipalities using the variation in ownership of water provision across time and space generated by the privatization process we find that child mortality fell 8 percent in the areas that privatized their water services and that the effect was largest 26 percent in the poorest areas we check the robustness of these estimates using cause specific mortality while privatization is associated with significant reductions in deaths from infectious and parasitic diseases it is uncorrelated with deaths from causes unrelated to water conditions

kyoto and carbon leakage an empirical analysis of the carbon content of bilateral trade abstract has the kyoto protocol induced carbon leakage we conduct the first empirical ex post evaluation of the protocol we derive a theoretical gravity equation for the carbon dioxide content of trade which accounts for intermediate inputs both domestic and imported the structure of our new panel database of the carbon content of sectoral bilateral trade flows allows controlling for the endogenous selection of countries into the kyoto protocol binding commitments under kyoto have increased committed countries embodied carbon imports from noncommitted countries by around 8 and the emission intensity of their imports by about 3 hence kyoto has indeed led to leakage

climate change policy market structure and carbon leakage abstract the 1997 kyoto protocol on climate change obliges the industrialized countries to initiate the international effort of abating anthropogenic greenhouse gas ghg emissions if such an initiative is to be taken the associated competitive effects may lead to significant relocation of developed countries energy intensive production this paper examines this issue i adopt an oligopolistic structure combined with increasing returns to scale production technologies to represent the strategic interaction among the firms producing energy intensive products this representation is then embedded within a multi regional computable general equilibrium model which in turn is used for quantifying these relocational effects the results suggest that significant relocation of energy intensive industries away from the oecd may occur depending on the type of market structure with leakage rates as high as 130 in which case ghg control policies in the industrialized countries actually lead to higher global emissions

trilemma dilemma and global players abstract this paper investigates the debate between the mundellian trilemma and the dilemma overall the global financial cycle magnifies the binding effect of financial openness on monetary policy autonomy and reduces the effectiveness of the floating exchange rate regime in isolating the domestic economy against financial pressures i provide empirical evidence that the trilemma does not morph into a dilemma furthermore the sensitivity to the global financial cycle depends more on the presence of global investors and global players than on the fluctuations of these financial forces

testing for food market integration revisited this article considers the statistical performance of four commonly used econometric tests for market integration the law of one price the ravallion model cointegration and granger causality a spatial price equilibrium spe model that is subject to both production shocks and general price inflation and mimics many of the key characteristics of integrated food markets is constructed the model is used to generate food price time series of lengths that are typical of the short sample sizes available in most developing countries for both instantaneously integrated and independent markets a series of monte carlo experiments on these artificial food price time series are performed which show that all four of the conventional tests for market integration are statistically flawed

the modern history of exchange rate arrangements a reinterpretation we develop a novel system of reclassifying historical exchange rate regimes one key difference between our study and previous classifications is that we employ monthly data on market determined parallel exchange rates going back to 1946 for 153 countries our approach differs from the imf official classification which we show to be only a little better than random it also differs radically from all previous attempts at historical reclassification our classification points to a rethinking of economic performance under alternative exchange rate regimes indeed the breakup of bretton woods had less impact on exchange rate regimes than is popularly believed

the international price transmission in stock index futures markets i introduction numerous studies have investigated market linkages and price transmission mechanisms in major international equity markets employing the analytical framework of the vector autoregression var or its variant the error correction model ecm 1 studies such as von furstenberg and jeon 1989 eun and shim 1989 and koch and koch 1991 focus on the short run dynamic pattern of price transmission others like taylor and tonks 1989 and francis and leachman 1998 are primarily interested in the long run pattern of price transmission more recently an increasing number of studies explore both long and short run patterns of price transmission included in this last set are the works of malliaris and urrutia 1992 arshanapalli and doukas 1993 masih and masih 2001 and bessler and yang 2003 among others this study extends the examination of international price transmission to stock index futures markets the article contributes to the existing literature in three aspects first a relatively new empirical framework is applied to allow for inferences of price transmission at three different time horizons instantaneous the short run and the long run building on recent advances in statistical analysis of causal modeling using directed acyclic graphs dags as in spirtes et al 2000 pearl 1995 2000 and swanson and granger 1997 this study is able to explore the contemporaneous causal pattern underlying the correlations among market innovations the existence of strong contemporaneous correlations among market innovations has been well documented in the united states and international stock markets by agmon 1972 eun and shim 1989 koch and koch 1991 housbrouk 1995 and bessler and yang 2003 it is also well recognized by agmon 1972 849 and eun and shim 1989 246 that contemporaneous correlations among market innovations reflect the phenomenon that new information in one market is transmitted and shared by other markets in contemporaneous time due to immediate response to price changes between markets however more in depth analysis on exactly how instantaneous price transmission among market innovations is conducted in international equity markets has not yet been well addressed in the existing literature although bessler and yang 2003 touch on the issue the necessity of imposing constraints in the spirit of the block recursive structure noted by koch and koch 1991 in the dag analysis of var innovations is proposed and discussed thoroughly in this study second innovation accounting analysis is more thoroughly explored in the study innovation accounting tools i e impulse response analysis and forecast error variance decomposition have been commonly used to summarize the dynamic pattern of price transmission among international financial markets the importance of the factorization of innovations i e var residuals in yielding sound inference has been well acknowledged theoretically by bernanke 1986 sims 1986 and swanson and granger 1997 the application of the dag technique as discussed in swanson and granger 1997 and explained in the next section is further key to innovation accounting analysis in this study the instantaneous price transmission pattern between market innovations as identified by the dag analysis provides a data determined solution to the basic problem of orthogonalization of residuals from the ecm and thus is critical to impulse response analysis or forecast error variance decompositions swanson and granger 1997 argue that compared to the choleski decomposition the dag based structural decomposition is sensible but not subjective because it allows for the properties exhibited by the data although several recent studies such as those by bessler and yang 2003 bessler et al 2003 haigh and bessler forthcoming and yang 2003 have used the dag based structural decomposition in a similar setting the study is the first attempt responding to the suggestion by swanson and granger 1997 364 of investigating the empirical implications of the dag based contemporaneous causal modeling

option valuation with co integrated asset prices abstract this paper investigates theoretical and practical aspects of options that are based upon two or more assets which are co integrated for this purpose a new discrete time model of asset prices is developed a model featuring both the co integration property as well as stochastic volatilities using a garch equilibrium based option pricing approach it is shown that when volatilities are deterministic the option prices do not depend on the co integration parameters except for the mis specification effect as to the manner in which the volatilities are estimated however with stochastic volatilities the option prices explicitly depend upon the co integration parameters in order to understand these results better this paper also examines a continuous time diffusion limit of the asset price system and empirically studies the co integration effect using spread options based upon the s p500 and the nasdaq100 these numerical results suggest that consideration of co integration can substantially alter the value delta and vega of a spread option