Integration or fragmentation? A closer look at euro area financial markets

This chapter examines the degree of integration in euro area financial markets. To that end, it estimates overall and country-specific integration indices based on a panel vector-autoregression with factor stochastic volatility. The results indicate a more heterogeneous bond market compared to the market for lending rates. In both markets, the global financial crisis and the sovereign debt crisis led to a severe decline in financial integration, which have fully recovered since then. The chapter furthermore identifies countries that deviate from their peers either by responding differently to crisis events or by taking on different roles in the spillover network. The latter analysis reveals two set of countries, namely a main body of countries that receives and transmits spillovers and a second, smaller group of spillover absorbing economies. Finally, the chapter demonstrates by estimating an augmented Taylor rule that euro area short-term interest rates are positively linked to the level of integration on the bond market.