Financial market integration and cross-border spillover effects in Europe

The ongoing political, legal, and economic harmonization within the European Union has lead to a higher degree of integration of national financial markets. The introduction of the single European currency, the euro, eliminated a traditional source of risk to international portfolio investors. In light of these developments, Part I of the empirical analysis had the following objectives: (1) to determine the relative importance of country, sector, and industry factors in explaining individual company's stock return behavior in the wake of the formation of the European Union, (2) to identify the multiple factor model, consisting of country and/or sector and/or industry factors, that was best at explaining European stock returns over the observation period, (3) to discover cross-sectional differences and non-stationarity in the industry portfolio return sensitivity to country, sector, and industry factors, (4) to find out whether the European market had become more independent from the other two major trading areas, the US and the Pacific Rim, over the period 6/1994 to 6/1999, and (5) to quantify industry structure-related changes in portfolio diversification benefits in European stock portfolios. Diversification benefits of country portfolios still outweighed diversification benefits of European industry portfolios. However, evidence was found for a gradual change in the degree of homogeneity within European industries in the wake of the ongoing harmonization of European financial markets. It seems reasonable to assume diversification effects in the future to become even more pronounced for portfolios generated within a country market but across industries. The main objective of Part II, was to determine the valuation effects of merger and acquisition announcements on national rivals (intra-industry effects) and European rivals (inter-country effects). Conducting various cross-sectional return analyses, country and industry-specific sources of intra-industry effects and inter-country effects were identified. With the elimination of foreign exchange rate risks, following the introduction of the single currency on January 1, 1999, cross-border spillover effects have become more pronounced. The hypothesis that the introduction of the euro facilitates the transmission of (private) information across geographic markets boundaries is clearly supported by the findings of the cross-sectional regression analysis.