Analysing changes in market integration through a cross-sectional test for the law of one price

This paper presents a theoretical argument that the relationship between price differences and per capita income differences across locations can be used as a cross-sectional test for the law of one price. Since the relationship should be statistically insignificant or very weak in an integrated economy, its strength can measure the extent of goods market integration. A sequence of cross-sectional estimations for a number of points in time provides the temporal pattern of integration, so enabling changes in integration to be traced. The basic equation may be augmented by additional variables representing potential culprits behind market segmentation so as to estimate their impeding impact to integration. This methodology is empirically verified by applying it to the Russian domestic market. It is found that integration of Russia's goods market tends to improve with time; a number of culprits behind market segmentation are identified. Copyright (C) 2004 John Wiley Sons, Ltd.