The euro and us: The role of global and local factors in financial market integration
This article is part of the thematic series “The euro and us”. It builds on our previous analysis of crises and their impact on financial market integration of selected European countries with the euro area. The focus now shifts to the role of common (global) shocks in the financial alignment of euro candidates (the Czech Republic, Hungary and Poland) with selected euro area countries. Our approach, based on the law of one price, combines price-based and event-based measures of alignment. Price-based measures – beta-convergence and sigma-convergence – capture the speed and degree of market convergence. In contrast, gamma-convergence, derived from event-based measures, shows the extent to which asset prices are driven by common global factors. Together, these methods provide a deeper insight into the evolution of financial alignment across different financial market segments, which may prove useful for future euro adoption.
In a recent analysis[1] we introduced the concept of financially integrated markets, outlined the advantages and disadvantages of deeper financial interconnectedness and focused in more detail on the methods for measuring alignment using price-based indicators. The framework for measuring financial alignment can be approached in several ways, two of which are based on the assumption of the law of one price. These include price-based measures and news-based measures.[2] The more integrated the individual segments of the financial markets in the euro area accession countries are with the euro area market, the greater the influence of common (global) factors on the prices of the relevant assets, while the importance of local (national) factors diminishes. Greater integration thus supports the case for adopting the single currency, the euro. As alignment (integration) increases, individual segments of the financial market are also expected to be less likely to act as sources of counter-cyclical (asymmetric) shocks. Mitigating these shocks is crucial for the effective conduct of monetary policy within a monetary union.
Price-based measures include beta- and sigma-convergence.[3] Beta-convergence expresses the speed of yield convergence in financial markets, with a negative coefficient indicating ongoing convergence – the closer it is to -1, the faster the process. Sigma-convergence focuses on the dispersion of yield differentials on the same assets across countries and determines the degree of market alignment; sigma-convergence occurs when the dispersion approaches zero. The lower the sigma parameter, the more favourable the conditions for the potential adoption of the euro. In reality, however, beta-convergence may not always be accompanied by sigma-convergence, and sigma-divergence may even occur. It is therefore important to consider both concepts simultaneously when assessing financial integration.
Calculations of the speed (beta) and degree (sigma) of alignment should also be complemented by news-based measures (gamma). These measures consist in monitoring the sensitivity of asset prices (exchange rates, interest rates, government bonds, equity indices) to local and global news. They are based on the assumption that, in a fully financially integrated area, the portfolios (balances) of individual entities are perfectly diversified, the level of systematic risk is identical for assets from different geographical parts of the integrated area, and local factors therefore become less important. Sensitivity is measured by the gamma parameter, which expresses the degree of similarity between the reaction of domestic asset prices to events and that of benchmark assets.[4] In other words, the gamma parameter represents the proportion of asset price changes that can be explained by common factors. Higher gamma parameter values indicate a higher degree of commonality; values above 1 indicate stronger transmission, i.e. a stronger reaction of local asset prices (e.g. stock indices or government bonds) relative to the benchmark asset. Conversely, negative values indicate an asymmetric reaction to events. From the perspective of future euro adoption, it would be beneficial if the gamma parameter values for euro candidates were close to 1.
The following text presents the results of news-based measures (gamma-convergence) for the same sample of countries as in the previous analysis (beta- and sigma-convergence). This sample includes selected euro candidates (the Czech Republic, Hungary and Poland) and selected current euro area members (Austria, Portugal, Italy and Slovakia) in relation to the euro area or, where relevant, Germany, covering the period from January 1995 to June 2024. The calculations are based on weekly data (averages of daily data) from Bloomberg and Refinitiv. Data are available from January 1995 for the foreign exchange and equity markets, from January 1999 for the money market and from January 2000 for the government bond market. The data set ends in June 2024 for all markets. The money market data consist of three-month interbank market rates, the foreign exchange market data consist of exchange rates of national currencies against the USD, the government bond market data consist of five-year government bonds, and the stock market data consist of national stock indices. The beta coefficient was estimated using regression analysis with time-varying coefficients, based on the methodology described in Babecký, Komárek, and Komárková (2017).[5]
The results of the news-based measures (see Chart 1) show a relatively significant influence of local factors on national foreign exchange markets, especially in the period before the global financial crisis (2008–2009), when the impact of global factors was minimal. In the following years, up to the end of the observation period, the impact of global news increased to around 40% in the cases of the Czech Republic, Hungary and Poland. The higher sensitivity of foreign exchange markets to global news can be attributed to the increased involvement of foreign investors.
Chart 1 – Sensitivity of asset prices to global news in the foreign exchange market relative to the euro area (gamma-convergence)
Source: Bloomberg, Refinitiv, authors’ calculations.
The global financial crisis had an uneven impact on the money market (see Chart 2), with the influence of global factors falling to 60% in Poland, rising to 30% in the Czech Republic and remaining almost unchanged at around 20% in Hungary after the crisis subsided. This reflects the specific characteristics of the candidate countries’ monetary policies. The recent inflationary episode (2021–2023) has also significantly affected gamma-convergence in the money market. Increased interest rate volatility in response to high inflation led to a sharp increase in the influence of global news in Hungary, while from 2022 onwards, the transmission of global news among the observed euro candidate countries decreased slightly on average.
Chart 2 – Sensitivity of asset prices to global news in the money market relative to the euro area (gamma-convergence)
Source: Bloomberg, Refinitiv, authors’ calculations.
In the government bond market of the euro candidates, the dynamics of gamma-convergence were most strongly influenced by two key periods: the global financial crisis and the recent inflationary episode. As Chart 3a shows, the global financial crisis led to a decline in the importance of global news, with values in Hungary even turning negative, signalling a temporary break in convergence. However, the security and energy crisis, followed by the inflationary episode, reversed this trend. Since 2022, the importance of global news has risen to around 20% in Hungary and up to 40% in the Czech Republic and Poland.
Chart 3a – Sensitivity of asset prices to global news in the government bond market relative to the euro area (gamma-convergence): Euro candidates
Source: Bloomberg, Refinitiv, authors’ calculations.
The debt crisis (2010–2012) was the most significant factor affecting the sensitivity of assets to global news (gamma-convergence) in the government bond markets of selected euro area countries. As shown in Chart 3b, this crisis led to a sharp decline in the importance of global news, particularly in the case of Italy and Portugal, where values dropped from almost uniform levels to between 20% and 50%. The exceptions are Austria and Slovakia, where the evolution of the gamma-convergence was very different throughout the period under review. In Austria, the influence of global news remained high, above 90%, while in Slovakia it remained relatively low, between 20% and 30%. In recent years, the importance of global news has increased slightly in all selected euro area countries.
Chart 3b – Sensitivity of asset prices to global news in the government bond market relative to the euro area (gamma-convergence): Euro area countries
Source: Bloomberg, Refinitiv, authors’ calculations.
In equity markets, historical volatility and the global financial crisis have the greatest impact on gamma convergence. Both euro candidates (the Czech Republic, Hungary and Poland) and euro area countries were significantly affected by the global financial crisis of 2008-2009, during which the importance of global news increased in most of the countries under review (see Chart 4). In contrast, the pandemic and the inflationary episode had a much smaller impact on gamma convergence, indicating the relative resilience of equity markets to recent economic shocks. Two contrasting, and one might say extreme, examples of gamma-convergence are Slovakia and Germany. In Slovakia the impact of global news was virtually negligible or even opposite, i.e. negative (see Chart 4a), while in Germany it approached a value of one (see Chart 4b). This reflects the structure and capitalisation of the equity markets in these two countries.
Chart 4a – Sensitivity of asset prices to global news in the equity market relative to the euro area (gamma-convergence): Euro candidates and Slovakia
Source: Bloomberg, Refinitiv, authors’ calculations.
Chart 4b – Sensitivity of asset prices to global news in the equity market relative to the euro area (gamma-convergence): Euro area countries
Source: Bloomberg, Refinitiv, authors’ calculations.
Conclusions
News-based measures (gamma-convergence) complement the previous results based on price-based indicators (beta- and sigma-convergence). The results of gamma-convergence measures reveal significant differences in the sensitivity of asset prices to global news across markets and time periods. In the foreign exchange markets of euro candidate countries, local factors dominated before the global financial crisis, while the influence of global news increased after the crisis. In the money market, the impact of the global financial crisis has been mixed. The recent inflationary episode led to a short-term increase in the importance of global factors, followed by a gradual decline.
In the government bond market, the global financial crisis and the inflationary episode had a significant impact on the dynamics of gamma convergence among the euro candidates, while in the euro area countries the debt crisis played a key role. These crises temporarily reduced the importance of global news, but recent years have seen a gradual increase in its influence.
In equity markets, the global financial crisis had a dominant impact, while the pandemic and the inflationary episode had a much smaller impact on gamma convergence. Similar conclusions regarding increased alignment and shock transmission during financial crises are also reported by Nardo et al. (2022). In our analysis, Slovakia and Germany serve as examples of countries with different sensitivities to global news, with values ranging from negative or close to zero to almost one. These differences highlight the importance of the structure and degree of capitalisation of stock markets in individual countries for the transmission of news.
Overall, the results suggest that the transmission of global news to financial markets has stabilised after the recent inflationary episode. The process of financial integration underscores the importance of both global and local factors, with the sensitivity of markets varying depending on their type, time period and the economic characteristics of individual countries.
The overall convergence of financial markets with the euro area increased slightly towards the end of the period under review, which is a positive indication for the potential future adoption of the euro. The analysis of beta- and sigma-convergence from the previous study, combined with the gamma-convergence results, revealed that European financial markets exhibit varying degrees of alignment. While beta-convergence highlights a relatively fast process of yield alignment, sigma- and gamma-convergence suggest that alignment can be temporarily disrupted by crises and economic shocks. Nevertheless, a slight improvement in the alignment of financial markets with the euro area can be observed by the end of the period.
Differences between euro candidates and euro area countries. The Czech Republic, Hungary, and Poland generally exhibit slower beta- and gamma-convergence and higher sigma (dispersion), indicating a longer alignment process for their financial markets with the euro area. In contrast, euro area countries show lower dispersion and faster beta- and gamma-convergence, particularly in bond and money markets. However, visible fragmentation still persists across European financial markets.
Conclusion on overall alignment. The combined analysis of beta-, sigma-, and gamma-convergence shows that while differences in yields (measured by beta-convergence) can be reduced quickly, their dispersion (sigma-convergence) and the strength of news transmission (gamma-convergence) can be temporarily disrupted by crises. Therefore, the alignment of financial markets should be viewed as a continuous process, influenced not only by economic shocks but also by central bank measures implemented in response to these shocks.
Authors are Jan Babecký, Luboš Komárek a Zlatuše Komárková. The views expressed in this article are those of the authors and do not necessarily reflect the official position of the Czech National Bank.
References
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Babecký, J., Komárek, L., & Komárková, Z. (2024). Crises and Their Reflection on Financial Market Integration. CNB Global Economic Outlook, 12/2024, 14-18. (External link)
Babecký, J., Komárek, L., & Komárková, Z. (2017). Financial Integration at Times of Crisis and Recovery. In: R. Mirdala and R. R. Canale (eds.), Economic Imbalances and Institutional Changes to the Euro and the European Union, Vol. 18, pp. 173-191. Emerald Publishing Limited. (External link)
Babecký, J., Komárek, L., & Komárková, Z. (2016). Financial Market Alignment: Results (pp. 63-67) and Methodology (pp. 111-113). In: L. Matějková and K. Arnoštová (eds.), Analyses of the Czech Republic’s Current Economic Alignment with the Euro Area 2016. Czech National Bank. (External link)
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[1] See Babecký, Komárek and Komárková (2024).
[2] Another approach to measuring financial integration involves quantitative indicators (quantity-based measures), which focus on monitoring cross-border barriers faced by financial market participants. For a more detailed description and comparison of these approaches, see e.g. Baele et al. (2004) and Baltzer et al. (2008).
[3] The terms beta-convergence and sigma-convergence originate from the literature on economic growth and its dynamics; see, for example, Barro and Sala-i-Martin (1992). Their first application to financial markets was by Adam et al. (2002).
[4] Asset prices are monitored at the aggregate level, assuming that the benchmark asset responds only to global news.
[5] For a handy summary of the methodological framework, see Babecký, Komárek, and Komárková (2016).