# **5.** **<u>FGI and existing measures of financial integration</u>**

Of course, we are not the first to provide a measure of financial globalization/integration. Among the many existing measures, particularly well-known are the Chinn-Ito Index (CI), which measures the degree of capital account openness<sup>16</sup> (Chinn and Ito., 2006) and the Lane Milesi-Ferretti (LMF) capital flows-based measure, which looks at the ratio of Foreign Assets and Liabilities to GDP (Lane and Milesi-Ferretti, 2007). In this section, we discuss how such measures covary with ours. In addition, using Lane and Milesi-Ferretti database, and following Umutlu et al. (2010), we also compute the ratio of foreign portfolio equity liabilities to GDP (FEL), the ratio of Foreign Liabilities to GDP (FL), the ratio of foreign assets to GDP (FA), and the ratio of foreign portfolio equity assets to GDP (FPEA). The correlations between these variables, the corrected FGI, and uncorrected financial globalization indices, UFGI and UFGI10 presented in section 2, are reported in table 5 below.

**Table 5:** Correlation between financial integration measures

||FGI|UFGI|UFGI10|CI|FPEL|FL|LMF|FA|FPEA|
|---|---|---|---|---|---|---|---|---|---|
|FGI|1.00|||||||||
|UFGI|0.87|1.00||||||||
|UFGI10|0.70|0.75|1.00|||||||
|CI|0.42|0.41|0.23|1.00||||||
|FPEL|0.25|0.26|0.20|0.21|1.00|||||
|FL|0.13|0.17|0.09|0.27|0.55|1.00||||
|LMF|0.12|0.16|0.09|0.27|0.54|0.99|1.00|||
|FA|0.11|0.15|0.09|0.28|0.52|0.96|0.99|1.00||
|FPEA|0.01|0.03|0.00|0.19|0.37|0.70|0.77|0.83|1.00|

Notice first that the correlation between our corrected and uncorrected measure is about 0.87, while the correlation between our measure and Pukthuanthong and Roll’s (2009) is about 0.70. When we look at the correlation of the FGI with the other measures, the measure that displays the highest correlation with our FGI is Chin and Ito’s _de jure_ one. Among the Lane and Milesi-Ferretti based measures, instead, the one that displays the larger correlation is the ratio of foreign portfolio equity liabilities to GDP (FPEL). The finding is not surprising given our focus on stock market behaviors.

In order to see how our own measure compares with the other financial integration measures (IMs), in table 6, we replicate column 1 in table 3 using all the different measures on the same data set.<sup>17</sup> The results are presented in table 6 below, where all variables are standardized, so that the different coefficients can be easily compared.

It is worth noticing that, using the stock-based measures from Lane and Milesi-Ferretti’s data set, financial globalization seems to have little effect on volatility, and if it has one, it is an amplifying one. Contrary, the FGI and CI are negatively correlated with volatility. The fact that the results with our measure and CI’s are similar was not expected, given the _de jure_ nature of the latter index.

> 16 The index is based on the restrictions on cross-border financial transactions reported in the IMF’s _Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER)._

> 17 This explains why the number of observations dropped from 19,294 to 16,792. The LMF data set is available up to 2014; hence, the estimates in this table include the 1993-2015 period (given that the IM enters with a lag).

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