Measuring Financial Integration in Europe: a price-based approach for equity and bond markets

The economic literature, while recognizing the added value of financial market integration, does not offer a clear cut answer on the best measure(s) of this integration. We compute three possible measures based on the sensitivity of domestic European stock markets to global, US or European shocks. The common rationale is to measure the extent to which domestic stock (bond) market volatility incorporates external shocks, following the idea that in more integrated markets shocks transmit more easily. The first method, based on correlation of stock market returns, offers two measures of integration. Firstly, the proportion of shocks generated in EU and US markets that actually hit EU domestic markets and secondly domestic sensitivity to foreign shocks. The third method, based on common factor portfolios, identifies a set of recurrent common patterns in EU and World stock and bond markets. Domestic returns are then matched against these global factors to see the degree of co-movement. This technical report collects JRC contribution to the European Financial Stability and Integration Review (SWD (insert number), Brussels 25 April 2016)JRC.G.1-Financial and Economic Analysi