Financial integration in European equity markets: The final stage of Economic and Monetary Union (EMU) and its impact on capital markets

This paper examines the extent of financial integration in European equity markets before, during and after the adoption of the single currency on 1 January 1999. Two groups of European economies are examined. The first set comprises the Member States of the European Union (EU) that participated in the euro (the Euro-11) [Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, Netherlands, Portugal and Spain]. The second set consists of the remaining Members of the Euro-15 [Denmark, Greece, Sweden and the United Kingdom] along with Norway and Switzerland. Multivariate cointegration procedures, Granger-causality tests and generalised variance decomposition analyses based on error-correction and vector autoregressive models are conducted to examine long and short-run relationships among these markets. The results indicate that there is a stationary long-run relationship and significant short-run causal linkages between the equity markets of both the euro and non-euro currency areas. However, while the large equity markets remain the most influential, the lower causal relationships that exist between these and at least some middle (Belgium, Spain and Netherlands) and small (Ireland, Luxembourg, Finland and Norway) equity markets suggests that opportunities for international portfolio diversification in European equity markets may still exist.