Putting the Emu Integration into a New Perspective: The Case of Capital Market Holdings

Abstract

This article investigates by means of an augmented gravity model, the impact of EMU on financial market integration across time by assessing its effect on capital (equities and bonds) holdings. We contribute to the respective literature by investigating this effect from a global perspective and also investigate the case of a pre-EMU effect on both equity and bond markets. Furthermore, we focus on the potential impact of recent financial crisis on international equity and bond holdings. Our estimates indicate that intra-EMU integration effect improved in both equity and bond markets during the period close to the formation of EMU i.e. 1997, 2001 and 2002. In the case of the EMU equity market, this effect is mostly centered on 2001 (18% increase of EMU holdings) reflecting the beneficial impact of EMU and the introduction of the euro, while in the case of bond market this EMU effect is centered on 1997 (50%), reflecting the existence of pre-EMU integration effects. These integration effects have been also accompanied by increased demand from the side of non-EMU investors in both markets. Lastly, these integration effects weaken significantly after 2007, mainly reflecting a post-crisis disintegration of EMU capital markets both internally and globally. These findings may be regarded as a red flag over the current status quo within EMU which is characterized by low levels of integration. This finding provides support for a push for a new EMU architecture in the form of greater fiscal and financial integration and supervision. Only in this way will EMU become a true currency union.