European Capital Markets with a Single Currency

By Jean Dermine; Pierre Hillion | Go to book overview

Executive Summary

One of the greatest events in financial history will occur in 1999: the birth of the euro and the emergence of a unified European capital market. Although a large series of papers and conferences has been concerned with the timing and sequencing of the introduction of the new currency and with an estimate of the costs that would be incurred, few published studies have attempted to evaluate the medium-term impact of a single currency on European capital markets. One single question is being addressed in this book: Once the euro is in place, what is likely to change in European capital markets? This can be broken down into other, more specific questions. How is the structure of the bond, equity and derivative markets going to be affected? Are these markets going to be fully integrated? Is the disappearance of exchange rate uncertainty going to affect risk premia on the equity and corporate debt markets? Is the euro going to compete with the US dollar and does this matter? Is the introduction of the euro likely to change the sources of competitive advantage of financial institutions? What are going to be the key factors for success in the financial industry.? The European Capital Markets Institute commissioned a report to address these issues. Drawn from various countries and fields of research--banking, economics and finance--the contributors analyse the structural effects of the introduction of the euro on European capital markets.

The book is divided into four major parts. The first analyses the macro-monetary economic environment under the euro, including its international role; the second part analyses the impact of the euro on the bond market--public and corporate-- and the derivative industry. The third part analyses the impact of the single currency on equity markets. Finally, the fourth part analyses the impact of the euro on the competitive dynamics of the fund management and investment banking industries.

In the first chapter, Dermine presents an overview of the various channels through which the euro will affect capital markets. A complete analysis of these effects follows in the subsequent nine chapters. A main argument is that national currency was a main source of competitive advantage in the bond, equity and foreign exchange markets. This arose because of a well-documented 'home bias' preference for asset allocation and a local expertise in monetary policy. The changeover to the euro will erase this significant source of competitive advantage raising the question of the significance of economies of scale and size in an integrated euro market. Moreover, Dermine points out that the inability of individual countries to devalue their currencies could change the nature of credit risk; this calls for a larger degree of international diversification

In the second chapter, Gros and Lannoo provide a detailed description of the monetary institutions that will prevail. They point out that European capital markets will not be perfectly integrated because domestic central banks will have incentives to retain national responsibilities and idiosyncrasies to protect local employment. Moreover,

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