European Financial Integration and Emu Expectations

With the lifting of remaining capital controls inside the EU in 1990, an essential step towards EMU was taken. This raises the questions of whether on the one hand there is an observable convergence of interest rates inside the EU and on the other if alongside this financial integration, EMU expectations are mirrored. This paper has presented a theoretical argument and empirical justification that in order to determine the extent of capital market integration and measure EMU expectations, an analysis of RIP is insufficient. By splitting RIP into its component risk premia, we could draw a more detailed picture of the situation. The outcome is that we have found that certain countries are still burdened with country and/or currency risk premia which are not reflected in the evolution of real interest differentials. Thus our study points to the necessity of doubting the validity of RIP as a proxy for EMU expectations