Are New and Old EU Members Becoming More Financially Integrated A Threshold Cointegration Analysis - Essay Example

1999; Fratzschner, 2001etc).This approach mainly uses the uncovered interest parity2 condition. The main limitation with this approach is that if data on financial instruments with similar characteristics are not available, then the interpretation of results based on the price or approach can be problematic. It is very difficult to get financial instruments of exactly similar characteristics in reality. Further, there is an argument that interest rate convergence need not necessarily occur in financially integrated markets.

This is because of the possibility of similar response of the markets to common factors even under non-convergence of interest rates also (Poghoshyan and Hann, 2007). The second approach is based on the cross border flows of capital. This approach estimates quantitatively the various legal and other barriers, which may affect financial integration through different angles of the decision process regarding investment (Bekaert and Harvey,1995;Adam etal, 2002; Baele etal, 2004 etc). However, cross border capital flows need not always be indicators of financial integration only.

It can be due to many other policies like monetary, fiscal, exchange rate policies and other circumstances (Eichengreen, 2003).In addition to this, according to European Commission (1997), the harmonization and coordination of various legal procedures for capital markets have become less important for their integration after the introduction of Euro. However, this is not the case for other financial markets according to the Commission. The third approach is based on the news-based indicators (Baele etal, 2004; Capiello etal, 2006).

According to this, under integrated financial markets, the prices of financial instruments will be affected more by the global news than the local news. This is because there will be well diversification of portfolios in the financially