NCPA - National Center for Policy Analysis


October 17, 2005

Before true economic globalization, financial markets acted relatively independently of one another. Globalization is making that less and less true. A new paper from the National Bureau of Economic Research details the integration between American and European financial markets.

The authors analyzed the daily returns between 1989 and 2004 for seven asset prices: short-term interest rates, bond yields, and equity market returns in both economies, as well as the exchange rate. They found that:

  • Shocks to U.S. short-term interest rates exert a substantial influence on euro-area bond yields and equity markets, and explain as much as 10 percent of overall euro-area bond movements.
  • The direct transmission of financial shocks within asset classes is magnified substantially, most by more than 50 percent, via indirect spillovers through other asset prices.

The authors conclude that an important share of the behavior of financial markets is explained by foreign asset prices. They find that:

  • On average, about 26 percent of movement in European financial assets is attributable to developments in U.S. financial markets.
  • In contrast, about 8 percent of U.S. financial market shifts are caused by European developments.
  • The larger importance of U.S. markets is found particularly for equity markets; for instance, movement in U.S. stock prices trigger corresponding change in the euro area, with more than 50 percent of the U.S. market developments being reflected in euro area stock prices.

Source: Carlos Lozada, "Interaction of U.S. and European Financial Markets," NBER Digest, September 2005; based upon: Michael Ehrmann, Marcel Fratzscher and Roberto Rigobon, "Stocks, Bonds, Money Markets, and Exchange Rates: Measuring International Financial Transmission," National Bureau of Economic Research, Working Paper No. 11166, February 2005.

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