Financial Integration And Domestic Sovereignty In European Stock Markets

n this study, we examine the level of stock market integration and the impact of sovereign risk on the pricing of European equity markets since the introduction of the euro. We use a multivariate GARCH(1,1)-M return generating model allowing for partial market integration in which sovereign risk is proxied by the sovereign yield spread computed relative to a common benchmark that is Germany. We find that domestic stock market risk is still significant after the introduction of the euro and that sovereign risk represents a non-negligible component -on average 15%- of the excess ex- pected return required for investing in the euro-zone as well as in a group of European stock markets enlarged to Switzerland and the UK.