The effects of the introduction of the euro on the volatility of European stock markets

Have convergence of European economies and introduction of the euro produced some effects on European stock markets? Theory suggests that stabilization of fundamentals should decrease variance of stock returns for historically unstable stock markets. We test this proposition with daily data for the period January 1988-May 2000 and apply a three-regime Markov switching model for the variance-covariance matrix among several stock indices, including the UK and the US. The analysis shows that introduction of the euro, after an initial burst of volatility common to all European stock markets, has indeed stabilized the Spanish and Italian stock markets. (C) 2002 Elsevier Science B.V. All rights reserved.