The Race to the Bund: Aggregate European and State-Level Integration from the EEC to Present

Abstract

Many scholars point to the decreasing yield spread between the benchmark German bund and other European states as a sign of unprecedented European integration since Maastricht. There are two possible issues with this claim. First, without a historical perspective on sovereign bond yields and their comovements, researchers cannot determine how current levels of integration compare to previous periods of European history. To my knowledge, no previous research examines European yields from the formation of the ECSC or EEC to present, let alone pre-war spreads. Second, the first two moments of yield spreads do not necessarily capture meaningful integration. While the spreads are certainly an important measure, we can better assess integration by examining the correlation of these yields. In this article, I address both of these issues as follows. First, I describe an alternative method of measuring integration in the sovereign bond market based on an eigendecomposition of the time-dependent correlation of yields and their first-order differences. This approach better measures integration than standard methods because it takes into account the degree to which a single dimension explains the structure and movement of yields. Second, I construct a dataset of ten-year sovereign bond yields for the EU-15 countries from 1987 to 2010, as well as subsets of these 15 countries from 1958-2010 and from 1872-1913. I then apply both standard yield spread analysis and the method proposed in this article to these three samples. The results of the standard yield spread analysis indicate that Europe has seen previous periods of comparable financial integration. However, based on the alternative method of this article, integration did not occur until the Single European Act of 1987 and the Maastricht Treaty of 1993. A period of stable and high integration is observed following the adoption of the Euro in 1999. Furthermore, both methods show that the recent global real estate and European fiscal crises have significantly degraded financial integration to a level not seen since Maastricht. In summary, this article contributes both a novel and useful methodological approach and a historical basis on which to evaluate modern European integration in the sovereign bond market.

Keywords: EU integration, sovereign debt, sovereign bonds

JEL Classification: F30, F33, F34, F02, B40, N24, O52