Title: The effect of the EMU on short and long-run stock market dynamics: new evidence on financial integration

Authors: Juan Angel Lafuente, Javier Ordonez

Addresses: Department of Finance and Accounting, Universitat Jaume I, Campus de Riu Sec. E-12080 Castellon, Spain. ' Department of Economics, Universitat Jaume I, Campus de Riu Sec. E-12080 Castellon, Spain

Abstract: This paper deals with the time evolution of stock market integration around the introduction of the euro. In particular we test whether the degree of integration between the main eurozone countries increased after European monetary union. The contribution of the paper to the extant literature is twofold: a) first, we take into account the potential long-run equilibrium relationship between stock indices allowing for structural changes in the cointegration space that might capture the effect of the introduction of the euro; b) we formally test the existence of greater financial integration after European monetary union across the main member countries and between these members and the UK. Empirical evidence reveal the existence of long-run equilibrium relationships between European stock markets even before the introduction of the euro. Our empirical findings suggest that financial integration is not the direct consequence of the removal of exchange rate risk due to currency unification. Rather, it arises as a result of macroeconomic convergence. This aspect is corroborated by the nature of the principal component structure of estimated conditional correlations.

Keywords: cointegration; dynamic financial integration; stock markets; European monetary union; EMU; stock market dynamics; structural change; euro introduction; equilibrium relationships; macroeconomic convergence.

DOI: 10.1504/IJFMD.2009.028946

International Journal of Financial Markets and Derivatives, 2009 Vol.1 No.1, pp.75 - 95

Published online: 14 Oct 2009 *

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