The Euro and European Financial Market Integration

We use a time-varying copula model to investigate the impact of the introduction of the Euro on the dependence between seventeen European stock markets during the period 1994-2003. The model is implemented with a GJR-GARCH-t model for marginal distributions and the Gaussian copula for the joint distribution, which allows capturing time-varying, non-linear relationships. The results show that within the euro area, market dependence increased after the introduction of the common currency only for large equity markets, such as France, Germany, Italy, the Netherlands and Spain. Structural break tests indicate that the increase in financial market integration started around the beginning of 1998 when euro membership was determined and the relevant information was announced. We also estimate time-varying dependence measures for non-euro European countries with the euro-zone equity market. The UK and Sweden, but not other countries outside the euro area, are found to exhibit an increase in equity market co-movement, which is consistent with the interpretation that these countries may be expected to join the euro in the future. The results are robust to the choice of numeraire provided the same currency is chosen for a pair of markets.