How to Determine whether Regional Markets are Integrated? Theory and Evidence from European Electricity Markets

Integrating national markets is a major regulatory target in the European en-ergy market. Yet, wholesale prices for electricity still differ significantly. Whether these price differences are caused only by limited interconnector capacities or also by lack of cross-border competition, is an open question. To address this ques-tion, we develop a new approach to determine to which extent price differences stem from limited participation in cross-border trade. We derive a theoretical in-tegration benchmark, using Grossman’s (1976) notion of a rational expectations equilibrium. We compare the benchmark to data from European electricity mar-kets. The data reject the integration hypothesis and indicate that well informed traders do not engage in cross-border trade