Integration or fragmentation? A closer look at euro area financial markets

This paper examines the degree of integration at euro area financial markets. To that end, we estimate overall and country-specific integration indices based on a panel vector-autoregression with factor stochastic volatility. Our results indicate a more heterogeneous bond market compared to the market for lending rates. At both markets, the global financial crisis and the sovereign debt crisis led to a severe decline in financial integration, which fully recovered since then. We furthermore identify countries that deviate from their peers either by responding differently to crisis events or by taking on different roles in the spillover network. The latter analysis reveals two set of countries, namely a main body of countries that receives and transmits spillovers and a second, smaller group of spillover absorbing economies. Finally, we demonstrate by estimating an augmented Taylor rule that euro area short-term interest rates are positively linked to the level of integration on the bond market.