DP7314 What Lies Beneath the Euro's Effect on Financial Integration? Currency Risk, Legal Harmonization, or Trade?

Author(s): Sebnem Kalemli-Ozcan , Elias Papaioannou , José Luis Peydró-Alcalde

Publication Date: June 2009

Keyword(s): euro , exchange rate , financial integration , legislation , regulation , trade

JEL(s): F10 , F15 , F30

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP7314.asp.asp

Although recent research shows that the euro has spurred cross-border financial integration, the exact mechanisms remain unknown. We investigate the underlying channels of the euro's effect on financial integration using data on bilateral banking linkages among twenty industrial countries in the past thirty years. We also construct a dataset that records the timing of legislative-regulatory harmonization policies in financial services across the European Union. We find that the euro's impact on financial integration is primarily driven by eliminating the currency risk. Legislative-regulatory convergence explains part of the total effect, whereas trade has no role in explaining the euro's positive effect on integration.