An efficient market is one, which is able to absorb new information into the security prices instantly. In the context of international markets, efficiency is not just about the individual markets but also about the pricing of these individual markets relative to the world index. The issue of international market efficiency revolves around international capital market integration versus segregation.
International Capital Market Integration: Capital can flow freely across national borders where investors can respond to new global information and exploit arbitrage opportunities; the financial asset law of one price applies to assets traded in the internationally/globally integrated capital market.
International Capital Market Segregation: Barriers exist that prevent the market to be as efficient as the integrated capital market.
Capital Mobility Barriers/Impediments
- Psychology: Investors fear the unknown of investing in foreign assets.
- Legal: Governments restrict the flow of foreign capital.
- Transaction Costs: Investment planning and maintenance for assets located abroad often incurs greater cost than similar domestic assets.
- Taxes: Investors may be exposed to high taxation abroad and/or double taxation of an international asset’s return.
- Exchange Rate Risk: Investors need to determine an exchange rate risk premium for the return on a foreign asset.
- Political Risk: Governments can take any number of adverse actions against foreign investors.
Factors Favoring International Capital Market Integration
- International Stock Listing: Some multinational companies have equity shares listed on multiple exchanges; this helps facilitate a law of one price environment for these securities.
- International Banking: Corporations and governments borrow in foreign markets, facilitating the law of one price for a real/inflation adjusted rate of return
- International Investing: Global investors hold assets in many countries; this creates pressure for transparency, liquidity and efficiency for an integrated international market.