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The dynamics of European financial market integration

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  • G. EVERAERT

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  • L. POZZI

Abstract

We investigate financial market integration in Europe with a panel of 16 European and 4 non- European countries over the period 1970:01-2012:10. The theoretical framework considered is an international CAPM for equity excess returns with multiple common factors - a world factor and EU and euro country group factors - augmented with a local country-specific factor. While in the literature it is common practice to use observed variables and proxy’s for the factors, we estimate the ICAPM as a dynamic unobserved factor model with stochastic factor loadings and stochastic volatilities for the factor error terms. A measure for the time-varying degree of integration is calculated for each country with respect to the world and with respect to both country groups. The results suggest that, for all countries, integration has occurred mainly at the global level. The EU has been an additional driving force of financial market integration, especially for the initial EU member states in the 1970s. The contribution of the euro factor to financial market integration has been more important for the peripheral countries from the euro area than for the core economies. We also find that while the Great Recession (2008-2009) has temporarily increased the degree of financial market integration of European countries, no similar e ect can be observed with respect to the ensuing euro area debt crisis (2010-2012).

Suggested Citation

  • G. Everaert & L. Pozzi, 2014. "The dynamics of European financial market integration," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 14/877, Ghent University, Faculty of Economics and Business Administration.
  • Handle: RePEc:rug:rugwps:14/877
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    File URL: http://wps-feb.ugent.be/Papers/wp_14_877.pdf
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    References listed on IDEAS

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    1. Bekaert, Geert & Harvey, Campbell R. & Lundblad, Christian T. & Siegel, Stephan, 2013. "The European Union, the Euro, and equity market integration," Journal of Financial Economics, Elsevier, vol. 109(3), pages 583-603.
    2. Lorenzo Cappiello & Robert F. Engle & Kevin Sheppard, 2006. "Asymmetric Dynamics in the Correlations of Global Equity and Bond Returns," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 4(4), pages 537-572.
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    5. Marco Del Negro & Christopher Otrok, 2008. "Dynamic factor models with time-varying parameters: measuring changes in international business cycles," Staff Reports 326, Federal Reserve Bank of New York.
    6. Geert Bekaert & Campbell R. Harvey & Angela Ng, 2005. "Market Integration and Contagion," The Journal of Business, University of Chicago Press, vol. 78(1), pages 39-70, January.
    7. Sangjoon Kim & Neil Shephard & Siddhartha Chib, 1998. "Stochastic Volatility: Likelihood Inference and Comparison with ARCH Models," Review of Economic Studies, Oxford University Press, vol. 65(3), pages 361-393.
    8. Harvey, Campbell R, 1991. " The World Price of Covariance Risk," Journal of Finance, American Finance Association, vol. 46(1), pages 111-157, March.
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    10. Chang-Jin Kim & Charles R. Nelson, 1999. "State-Space Models with Regime Switching: Classical and Gibbs-Sampling Approaches with Applications," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262112388, March.
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    More about this item

    Keywords

    Financial Markets; Stock Markets; Integration; Dynamic Factor Model; Unobserved Components; State Space; Stochastic Volatility;

    JEL classification:

    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models

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