Some new evidence on exchange rates, capital controls and European Union financial integration

Abstract

We tested for financial integration among the major European Union countries using a new test, developed by Im, Pesaran, and Shin (1997), that allowed us to confirm or reject covered interest rate parity depending on whether a panel data set comprising covered interest differentials is stationary or not. Employing a panel data unit root test offers substantial advantages over the univariate Augmented Dickey Fuller tests that might accept the null of nonstationarity on account of low test power. Despite the turbulence in the exchange rate mechanism during the early 1990s, we find evidence of onshore covered interest parity and therefore of financial interdependence of domestic interest rates.