Financial integration in Europe : Evidence from Euler equation tests

This paper applies Obstfeld's Euler equation tests to assess the degree of financial integration in the European Union. In addition, we design a new Euler equation test which is intimately related to Obstfeld's Euler equation tests. Using data from the latest Penn World Table (Mark 6), we arrive at the following ranking of financial integration in the European Union: low integration (Greece and Portugal) intermediate (Austria, Denmark, Finland, France, Ireland, Italy, Spain and Sweden) and high (Belgium, Germany, the Netherlands and the United Kingdom). Furthermore, it appears that there is still significant room for risk diversification among European Union countries.