The integration of the European Stock Markets in the World Market: a new econometric approach

The aim of this paper is twofold. Firstly, we apply the model proposed by Jorion and Schwartz in their seminal article dated from 1986 in the Journal of Finance, and in this paper we test the integration of the European stock markets in the world market. Secondly, we apply the model using a recent high frequency data set, obtained after the single currency has been implemented. In this setting, we have assumed the European market as the domestic market, and we test the degree of integration of this in the world market. As in Jorion and Schwartz, we are also testing the validity of a specific model used to compare expected returns and risk. A main point in this paper is the implementation of sophisticated tools, in econometric terms, due to the specific problems that arise from high frequency data in financial time series, namely volatility clustering, volatility dependencies and fat tails. In this paper, the econometric model used is a nonlinear panel model where the error term present fat tails and ARCH characteristics. This model is estimated using the maximum likelihood estimation technique. As in the literature is sometimes discussed, ARCH effects can be the symptom of time-varying parameters.