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EU membership involves political and economic reforms
which influence financial markets in the new member states.
This study empirically explores and quantifies the effects of
EU accession on the risk and return of equity markets in eight
Central and Eastern European markets joining the EU in 2004.
The study also incorporates a review of how the influence of
macroeconomic variables and the level of integration with
global and European markets change as a result of
EU membership.
Based on empirical tests using weekly data over ten years,
this study concludes that EU membership results in a
significant decline in equity market volatility and a
significant increase in risk-adjusted, but not absolute,
equity returns. Furthermore, the study suggests that equity
markets in new EU member states become increasingly
influenced by global rather than local macroeconomic
factors after the EU accession and that the level of integration
with global markets increases.



1. Introduction

Subsequent to the dismantling of the Soviet Union in the 1990s, improved political stability and reforms have substantially changed the economic environment in the Central and Eastern European economies. The political transition has resulted in improved conditions which in turn have led to real economic growth superior to that in Western Europe as well as to a continuous flow of capital into the region.
An event that has had significant political impact on a group of Central European economies is the accession to the European Union (EU) on the 1st of May 2004. As of this date, ten additional states joined the EU, bringing the total number of member states to 25. Eight of these ten new member states are former Soviet Union satellite states located in Central Europe and the Baltic region. The accession process is likely to have affected not only the development and integration of the Central European region but also the perception of the respective markets by international investors.

2. Literature Review

This chapter offers a review of the relevant theoretical foundation and existing empirical evidence upon which this study is based. The chapter is divided into four topical sections.
The first section introduces the performance characteristics of emerging equity markets, which help explain the subsequent theoretical review relating to market liberalisation and integration. While findings from several emerging markets are included, the focus remains on equity markets in European transition economies. In addition to a review of definitions and theories around market liberalisation and market integration, section two also describes the main conclusions on liberalisation and integration effects on financial markets. The third section reviews the area of regional market integration and introduces studies relating to the macroeconomic effects of the EU enlargement. The fourth section explores theory and associated empirical evidence of an area linked to the EU accession preparations, namely corporate governance and how it is linked to equity performance characteristics.

3. Definition of Research Questions and Hypotheses

As discussed in the previous chapter, the areas of emerging market finance and market integration have received attention in previous research. Despite this existing research, there are areas which have not been fully explored. This section serves to introduce the unexplored research questions and associated research hypotheses that will be empirically tested within the scope of this study. The research questions are derived from the current basis of theory and empirical evidence.
This study aims to extend the existing market integration research by applying an approach that focuses on an event which occurs at a later stage in the market integration process but that is nevertheless likely to have a significant impact on the level of market integration. Understanding the effects on emerging equity markets as a consequence of accession to the EU provides an important complement to the existing academic findings. If it can be shown that emerging economies where liberalisation has already occurred, experience additional integration as a result of accession to an established economic trade union, conclusions about the market integration process in general can be derived.

4. Methodology

With the research hypotheses defined and formulated in the previous chapter, the focus is shifted to describing the research methodology applied to explore and test the respective research hypotheses. In several cases, multiple approaches are applied to provide improved insights and understanding of the empirical findings.
Each research hypothesis requires a unique approach to test whether it can be rejected or not. Nevertheless, one important dimension which reoccurs across several research approaches is the date at which point effects are expected to occur. As will be discussed in the subsequent parts of this chapter, an understanding of this date is required for the analyses of all research questions. The EU accession process is discussed extensively in sub-section 5.1.3. However, in order to facilitate the discussion of the research approach it is helpful to indicate, already at this stage, that the effects of EU accession on the financial markets are expected to occur at the announcement of the accession decision rather than at the accession date itself. Further details on this assumption are provided in sub-section
The structure of this chapter follows that of Chap. 3 in the sense that each of the four research hypotheses is discussed in a separate section. Section 4.1 introduces the methodology applied for the initial two research hypotheses, both of which relate to the impact of EU accession on the level of integration. Section 4.2 contains the details of the methodology applied to test the EU accession effects on market performance, including impact on equity market volatility and return levels.

5. Review of Empirical Data

Prior to presenting the details and findings of the analyses, it is useful to introduce the empirical data. The analyses of this study require several types of empirical data to address the identified research hypotheses.
Finally, quantitative data on a selected number of local and global macroeconomic factors related to explaining the performance of equity markets are required to enable the detailed analysis of how different factors affect the performance of equity markets prior to versus after the EU accession.
This chapter includes a description and a review of both the qualitative and the quantitative data and associated sources applied within the scope of this study.

6. Findings and Discussion

With the research methods defined and the data samples explored, the focus now shifts to the presentation of the test results and the initial discussion of the statistical findings. Along with each empirical test presented in this chapter, key observations and findings will be presented and discussed. The overall conclusions and the interpretations of the findings in a broader context will be discussed in Chap. 7.
This chapter is structured according to the research questions. The chapter contains two main sections, each with two sub-sections. The first section discusses the findings from the tests of the two research questions on market integration whereas the second section explores the findings relating to the performance questions.

7. Conclusions

The aim of this study has been to provide empirical evidence regarding four research questions related to the effects on equity market integration and performance of EU accession among European transition economies. The four research questions are derived from existing academic research and address areas which have not yet been explored. The first research question empirically tests the effect on the level of co-movement between equity markets in European transition economies and global as well as European equity indices. The second research question investigates whether there is an impact of the EU accession on the level of influence global and local macroeconomic factors have on equity markets in European transition economies. Jointly, these two questions contribute to the understanding of the later stages of market integration. The last two questions explore the effects of EU accession on the volatility and the return levels of equity markets in transition economies.


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