DP7784 Deep Financial Integration and Volatility

Author(s): Sebnem Kalemli-Ozcan , Bent E Sørensen , Vadym Volosovych

Publication Date: April 2010

Keyword(s): firm volatility , foreign ownership , macro volatility , regional integration , social capital

JEL(s): E32 , F15 , F36 , O16

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP7784.asp

We investigate the relationship between financial integration and output volatility at micro and macro levels. Using a very large firm-level dataset (AMADEUS) from 16 European countries, we construct a measure of ``deep'' financial integration at the regional level based on observations of foreign ownership at the firm level. We find a significant positive effect of foreign ownership on the volatility of firms' outcomes in static as well as dynamic empirical frameworks. This effect survives aggregation and carries over to regional output, leading to a positive association between deep international financial integration and aggregate fluctuations. To identify the causal effect of integration on volatility we exploit variation in the transposition dates of the European Union-wide legislative acts from the Financial Services Action Plan (FSAP). We find that high trust regions located in countries who harmonized their capital markets sooner have higher levels of financial integration and higher volatility.