between U.S. and group of G7 markets, although evidence of bivariate cointegration is rather
weak. Furthermore, there is evidence that the extent of interdependencies has been rising since
2001, possibly due to the launching of Euro and growing integration of the Euro area markets.
Overall, our findings suggest limited diversification opportunities available to the U.S. based
investor interested in investing in ETFs of the G7 markets.
The rest of the paper is structured as follows. Section 2 provides a brief overview of
exchange-traded funds with a particular focus on Standard & Poors Depositary Receipts (SPDRs)
and iShares. Section 3 reviews recent findings in relation to equity market integration. Data and
methodology are described in Sections 4 and 5. Section 6 provides empirical results and Section
7 provides conclusions.
2. Background
2.1. Exchange-traded funds (ETFs)
Exchange-traded funds are considered to be one of the major financial innovations of the
past decade. ETFs are organized as funds or unit investment trusts that seek to track price and
yield performance of the underlying sector, domestic, international indices (www.amex.com).
ETFs allow investors to track a benchmark thus gaining an exposure to segments or entire
domestic or foreign markets with relative ease. Purchasing and selling ETFs for both retail and
institutional investors is easy due to similarities with trading stocks. This implies that buying on
margin and short selling (even on a downstick) are allowed. In the secondary market ETFs are
traded intradaily, like stocks or shares of close-end funds. In the primary market, when the fund
itself is the party of the trade, transactions take form of in-kind creation (redemption) process
through market specialists. This process involves depositing (receiving) a stock portfolio to
receive (redeem) a pre-specified amount of ETF shares. The in-kind transfer process underlies