Does the Law of One Price Hold in Euro-Area Retail Banking? An Empirical Analysis of Interest Rate Differentials across the Monetary Union

To measure integration, economic theory provides a clear background regarding price convergence: the law of one price. This paper is the first test of this law in euro-area retail banking. Since the law can be verified only on similar assets, we use recent harmonized data and a methodology that renders banking products homogeneous across countries, controlling for national factors. Econometric results signal that rates differ, and that markets are still segmented, because banking services are differentiated. Since supply factors play a driving role, there is room for improved integration. Moreover, where bank customers are stronger, rates are more homogeneous.