The Euro and Financial Integration

The goal of this chapter is to provide a quantitative review of the impact of European Monetary Union (EMU) on international financial integration. The degree of financial-market integration can be measured along several different dimensions and there is no widespread agreement about a single correct measure (Adam et al., 2001; Baele et al., 2004). De jure measures of financial market integration rely on the dating of financial-market liberalisations initiated by policy-makers. The effects of such liberalisation episodes are typically examined using event-study methodologies. De facto measures focus instead on the outcomes of such liberalisations. In so far as the impact of policy decisions will develop into outcomes gradually over time, it is likely that de jure and de facto measures will provide different views about the extent of financial-market integration. Moreover, de facto measures rely either on quantities, be it stocks or flows of equity, debt or foreign direct investment, or on asset prices or returns. Finally, some studies make use of conditional asset-pricing models and assess the relative importance of regional and local risk factors in explaining expected returns (Bekaert and Harvey, 1995; Hardouvelis et al., 2006): a greater degree of market integration results when expected returns are increasingly explained by regional risk factors and less by local risk factors.