Integration Of Financial Markets In The Euro Area Studies, The Mechanism Of The Changes In Portfolio Preferences Of Oecd Countries

Following the launch of the Euro in 1999, integration among Euro area financial markets increased considerably. As a result, portfolio home bias declined across the European financial markets. However, greater market integration has generated a new bias:portfolio Euro bias, a situation where OECD investors tend to hold large proportion of assets issued within the Euro region.The first part of this paper presents an overview of Euro area financial market integration with introducing the money market, bond market and the equity market. The second part of paper apply an empirical analysis of the economic factors at play behind the switch from home bias to Euro bias. We find that decline in default risk and transaction cost are two key determinants of the rise in portfolio Euro bias. The last part of the paper goes deeper into the effects of Euro bias on Euro area bond and equity markets. We observe that both government and corporate bond markets revealed clear signs of strain during the recent financial turmoil. Our results also reveal that the risk-reduction potential from geographic diversification within the Euro equity market is lower than that of the Euro sector diversification.