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ABSTRACT

The extent to which international goods and financial markets are integrated is an issue of

continuing interest for policymakers and market participants. On the one hand, a high

degree of economic and financial integration is beneficial since it can foster economic

growth, increasing risk sharing and allocating savings more efficiently, on the other hand,

however, it may also lead to high cross border economic interdependence and

transmission of shocks. Literature review indicates that, there is no unanimous definition

of financial integration. This study therefore focused on the type of financial integration

whose estimates are conducted by investigating the changes in the co movements across

countries between selected financial asset returns.

The general objective of the study was to determine the extent of financial integration in

the East African financial markets as documented by existing literature. To achieve thisobjective, literature review on financial integration in the developed markets of Europe,

the emerging markets of Asia and the African continent was conducted. Studies from

Europe and Asia indicated evidence of increased beta convergence in the financial

marketsStocks, Bonds and Treasury bills. However, empirical studies on integration of

the East African Community (EAC), focusing on the viability of a monetary union

showed partial convergence for the variables considered (Exchange rates, GDP, business

cycles, fiscal and monetary variables). The empirical studies concluded that, the three

countries tend to be affected by similar shocks and would therefore need significantadjustments to align their monetary policies and to allow a period of monetary policy

coordination to foster convergence that will improve the chances of a sustainable

currency union.

The overall conclusion of this independent study is the lack of empirical work on

financial markets integration with specific focus on the stocks and bonds markets,

indicating the lack of empirical evidence on the extent of financial integration and long-

run equilibrium of investment returns in the East African Financial markets.

Further research can therefore be conducted to examine the financial integration of equitymarkets using quantity-based measures such as market capitalization and also to

determine what constitutes significant adjustments for the EAC countries to be able to

align their monetary policies and to allow a period of monetary policy coordination to

foster convergence that will improve the chances of a sustainable currency union.


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CHAPTER ONE: INTRODUCTION

1.1 Background

Financial market development is an important component of financial sector development

and supplements the role of the banking system in economic development. In otherwords, financial markets are needed as an alternative source of financing, supplementing

commercial banks, which dominate the EAC financial sector with low competitiveness

(Gaertner, et al 2011). Specifically, capital markets assist in price discovery, liquidity

provision, reduction in transactions costs, and risk transfer. They reduce information cost

through generation and dissemination of information on firms leading to efficient markets

in which prices incorporate all available information [Yartey and Adjasi (2007), Garcia

and Liu (1999)].

A large body of research has found evidence that capital market development contributes

to economic growth, including in sub-Saharan African countries (Levine and Zervos,

1998; Adjasi and Biekpe, 2006b). Developed capital markets promote growth by

mobilizing domestic savings and investments and by efficiently allocating mobilized

resources to the domestic companies. In addition, deep and liquid local capital markets

can lessen vulnerability of an economy to external shocks, by reducing currency and

duration mismatches in raising funds. Cross-country evidence shows that financial

development can reduce income inequality by increasing the income of the poor. There

exists a certain minimum-efficient size of bond markets, because large issuance and

trading volumes are more economical (Eichengreen and Luengnaruemitchai, 2004).

Capital markets in the East African Community (EAC) face common challenges of low

capitalization and liquidity, but to different degrees due to the different levels of

development in the markets. To this effect, the respective countries have been pursuing

development of capital markets through regional integration.

Regional integration is a process in which states enter into a regional agreement in order

to enhance regional cooperation through regional institutions and rules. The objectives of

the agreement could range from economic to political, although it has generally become a

political economy initiative where commercial purposes are the means to achieve

broader socio-political and security objectives. It could be organized either on a


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supranational or an intergovernmental decision-making institutional order, or a

combination of both.

When investments of the same risk command different returns one would conclude that,

financial markets are not integrated because of restrictions like legal barriers which

prevent capital from freely flowing between countries. In other words, in an integrated

financial market, investments of the same risk always have exactly the same expected

return. For example, a country with uniform tax laws and regulation usually has an

integrated financial market because there are no circumstances where one'sreturn will be

reduced because of tax restrictions or different regulation.

The extent to which international goods and financial markets are integrated is an issue of

continuing interest for policymakers and market participants, whether firms, investors, or

financial intermediaries. On the one hand, a high degree of economic and financial

integration is beneficial since it can foster economic growth, increasing risk sharing and

allocating savings more efficiently. On the other hand, however, it may also lead to high

cross border economic interdependence and transmission of shocks.

The researcher notes that, there is no unanimous definition of integration in the literature.

In financial economics, markets are said to be integrated when only common risk factors

are priced and (partially) segmented when local risk factors also determine equilibrium

returns. Another, more general definition relates market and economic integration to a

strengthening of the financial and real linkages between economies. Typically, estimates

of the first definition of integration require sophisticated asset pricing tests (examples are

given by Bekaert and Harvey, 1995 and 1997). Estimates of the second, instead, are

usually conducted by investigating the changes in the comovements across countries

between selected financial asset returns (Dumas, Harvey and Ruiz, 2003). This study

focuses on the second type, particularly, the East African stocks and bond markets.
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1.2 Research Problem

Financial markets are integrated when the law of one price holds. This means that,

investment returns and prices ofinvestments of the samerisk within different countries in

a given region converge to a common figure. Beta convergence acts as a good measure of

determining the extent of financial integration and so is the law of one price. Existing

literature in general indicates that, there is evidence of increased beta convergence in the

financial markets Stocks, Bonds and Treasury bills. Most empirical studies on

integration have focused on the developed markets of Europe (Baele et al. 2004,

Cappiello et al. 2006, Babetskii et al.2007, Abad et al. 2009, Avadanei 2010) and the

emerging markets of Asia (Hung and Cheung, 1995, DeFusco et al. 1996, Moosa and

Bhatti 1997, Bhoi and Dhal 1998, Kaminsky and Schmukler 2001, Masih and Masih

2001, Cowen et al. 2006).

However, the empirical studies on the extent of financial integration of the East African

Community (EAC) focus on business cycles and macro-economic variables - Exchange

rates (real and nominal), GDP, fiscal policy variables and monetary policy variables. For

instance, Opolot and Osoro (2009) examined the nature and extent of synchronization of

business cycles from 1981 to 2000 and concluded that, there is hope for a monetary union

in the EAC, but further policy reforms would be necessary to stabilize the national

economies and the need for the EAC countries to increase policy co-ordination in order to

achieve the desired level of synchronization of macroeconomic fluctuations. Buigut and

Valev (2005) arrived at a similar conclusion. Mkenda (2001) and Buigut (2011)

investigated the convergence of real and nominal exchange rates. The findings of the

studies showed partial convergence for the variables considered and concluded that, the

three countries tend to be affected by similar shocks and would therefore need significant

adjustments to align their monetary policies and to allow a period of monetary policy

coordination to foster convergence that will improve the chances of a sustainable

currency union.

Emerging from these studies is the knowledge gap on the degree of beta convergence of

the investment returns of stocks and bonds in the East African Community financial

markets.
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1.3 Research Objectives

The general objective of the study is to conduct a review of existing literature to

determine the extent of financial integration in the East African financial markets. The

specific objectives generated from this general objective include;

To conduct literature review to determine the degree of integration in the EastAfrican financial markets.

To conduct literature review to determine long-run equilibrium of returns among theEast African financial markets.

To determine the knowledge gap on the degree of beta convergence of theinvestment returns of stocks and bonds in the East African Community financial

markets.


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CHAPTER TWO: THEORETICAL LITERATURE REVIEW

2.1 Introduction

Financial integration which lends its origin in the European Union, has theoretically been

covered extensively. As part of literature review, we focus our theoretical framework on

the definition, categories of financial integration, the measurement and benefits of

financial integration as well as the relevant economic theories.

2.2 Definition of Financial Integration

Existing Literature provides various alternative definitions of financial integration;

Baele et al. (2004) assume that, a market for a given set of financial instruments and/or

services is fully integrated if all potential market participants have the same relevant

characteristics as outlined below;

1. They face a single set of rules when they decide to deal with those financialinstruments and/or services.

2. They have equal access to the same set of financial instruments and/or services.3. They are treated equally when they are active in the market.

This definition of financial market integration contains three important features. First, it

is independent of the financial structures within regions. Financial structures encompass

all financial intermediaries institutions or markets and how they relate to each other

with respect to the flow of funds to and from households, governments and corporations.

Second, frictions in the process of intermediation i.e. the access to or investment of

capital either through institutions or markets can persist after financial integration is

completed. Financial integration is concerned with the symmetric or asymmetric effects

of existing frictions on different areas. Even in the presence of frictions, several areas can

be financially integrated as long as frictions affect these areas symmetrically. However, if

the frictions have asymmetric effects on the areas, the process of financial integration

cannot reach the completion point.

Third, definition of financial integration separates the two constituents of a financial

market, namely the supply of and the demand for investment opportunities. Full


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integration requires the same access to banks or trading, clearing and settlement

platforms for both investors (demand for investment opportunities) and firms (supply of

investment opportunities, e.g. listings), regardless of their region of origin. In addition,

once access has been granted, full integration requires that there is no discrimination

among comparable market participants based solely on their location of origin. When a

structure systematically discriminates against foreign investment opportunities due to

national legal restrictions, then the area is not financially integrated. An area can also be

partially financially integrated.

The definition of financial market integration is closely linked to the law of one price. The

law of one price states that if assets have identical risks and returns, then they should be

priced identically regardless of where they are transacted. In other words, if a firm issues

bonds in two countries or regions, it must pay the same interest rate to both sets of

bondholders If the law of one price does not hold, then there is room for arbitrage

opportunities. However, if the investment of capital is non-discriminatory, then any

investors will be free to exploit any arbitrage opportunities, which will then cease to exist,

thereby restoring the validity of the law of one price.

Baltzer et al. (2008) show it is easy to see that the law of one price is in fact an implication

of the above definition. If all agents face the same rules, have equal access and are treated

equally, any price difference between two identical assets will be immediately arbitraged

away. Still, there are cases where the law of one price is not directly applicable. For

instance, an asset may not be allowed to be listed on another regions exchange, which

according to our definition would constitute an obstacle to financial integration. Another

example is represented by assets such as equities or corporate bonds. These securities are

characterized by different cash flows and very heterogeneous sources of risk, and as such

their prices are not directly comparable. Therefore, alternative measures based on stocks

and flows of assets (quantity-based measures) as well as those investigating the impact of

common shocks on prices (news-based measures) may usefully complement measures

relying on price comparisons (price-based measures).


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requisite adjustment has been made for risk. If the differential in expected risk-adjusted

returns is greater than zero but less than or the same as the transaction cost, we can say

that markets are disintegrated but are nonetheless efficient.

Financial integration can also vary in strength from perfect integration to perfect

disintegration or segmentation. When expected real interest rates are not the same in the

markets in question (not perfect integration), then the markets are said to be segmented.

Segmentation is a result of lack of integration and this can happen due to high transaction

costs involved in arbitrage or market inefficiency (Guha et al., 2004).

Financial integration includes not only integration of financial markets or services but can

take other forms as well. These forms need not be interconnected nor are they advanced

forms (stages) of the integration process. Liebscher et al. (2006) show that integration can

take many forms and present various aspects:

Central Africa) or through dollarization, such as in Latin America and the

Caribbean.

ralization of the capital account.

of listing of securities on foreign stock exchanges.

2.4 Measuring Financial Integration

Various measures exist in the literature for assessing the level of financial integration.

The methods which are used most are connected with growing investment opportunities.

However, Ho (2009) says that a standard measure of financial integration is difficult to

develop. There are many types of financial transactions and some countries impose a

complex array of price and quantity controls on a broad assortment of financial

transactions. This leads to enormous hurdles in measuring cross-country differences in

the nature, intensity and effectiveness of barriers to international capital flows


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(Eichengreen, 2001). Given the variety of asset classes traded, the measurement of

financial integration is not straight forward (Kalemli-Ozcan and Manganelli, 2008).

Financial integration is often measured following the approach adopted by Baele et al.

(2004).

They consider three broad categories of financial integration measures:

Price-based measures, which capture discrepancies in prices or returns on assetscaused by the geographic origin of the assets. This category of measures is divided

into two methods of measurement: yield-based and country effects.

News-based measures, which measure the information effects from other frictions orbarriers. If the global news has relatively bigger importance than local news, the

degree of systematic risk should be identical across assets in different countries.

Quantity-based measures, which quantify the effects of friction faced by the demandfor and supply of investment opportunities.

Price-based measures measure discrepancies in prices or returns on assets caused by the

geographic origin of the assets. This constitutes a direct check of the law of one price,

which in turn must hold if financial integration is complete. If assets have sufficiently

similar characteristics, it can base these measures on direct price or yield comparisons.Otherwise it needs to take into account differences in systematic (or non-diversifiable)

risk factors and other important characteristics. The cross-sectional dispersion of interest

rate spreads or asset return differentials can be used as an indicator of how far away the

various market segments are from being fully integrated. Similarly, beta convergence, a

measure borrowed from the growth literature, is an indicator for the speed at which

markets are integrating. In addition, measuring the degree of cross-border price or yield

variation relative to the variability within individual countries may be informative with

respect to the degree of integration in different markets.

The news-based measures are designed to distinguish the information effects from other

frictions or barriers. More precisely, in a financially integrated area, portfolios should be

well diversified. Hence, one would expect news (i.e. arrival of new economic


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information) of a regional character to have little impact on prices, whereas common or

global news should be relatively more important. This presupposes that, the degree of

systematic risk is identical across assets in different countries; to the extent that it is not,

financial integration is not completed and local news may continue to influence asset

prices.

The quantity-based measures quantify the effects of frictions faced by the demand for and

supply of investment opportunities. When they are available, we will use statistics giving

information on the ease of market access, such as cross-border activities or listings. In

addition, statistics on the cross-border holdings of a number of institutional investors can

be used as a measure of the portfolio home bias. Of course, no measure can be used for

all markets, as the specifics of some market or the data available for implementing a

measure can differ across markets. However, the spirit is the same across all markets, as

they capture the extent of possible asymmetries.

Schfer (2009) presents that the classification of integration indicators can be geared to

the type of data collected or to the information revealed. With this approach, indicators

are calculated either on the basis of statistical data on actual business activities (e.g.

interest rate statistics) or by means of surveys of banks and consumers behaviour and

intentions. For example, surveys can be used, to learn about the banks international

strategies or about consumer attitudes towards foreign providers. With regard to the type

of information mined, the indicators can be either qualitative or quantitative. The latter

category, in turn, can be volume-based or price-based. Indicators can also be classified by

their contribution to the measurement of integration as specified in the three definitions

of the term given above.

Accordingly there are:

Indicators depicting the extent to which the economic objectives associated with theintegration process have been met. In other words, what progress has actually been

made on achieving


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Indicators depicting whether banks and consumers perceive the uniform internalmarket as a whole as their domestic market.

Indicators depicting the extent to which the legal prerequisites are in place for banksand consumers to take a pan-European view, i.e. how far the artificial hurdles have

been removed.

Two problems may arise with each of the three groups of indicators. Firstly, it may be

difficult to correctly measure the variables entered into the respective indicator owing to

limited data availability. Secondly, if this is not an issue, it will then be necessary to

check whether the calculated indicator permits constructive statements on the status of

retail banking market integration

2.5 Benefits of Financial Integration

Baele et al. (2004) or Economic Commission for Africa (2008) consider three widely

accepted interrelated benefits of financial integration: more opportunities for risk sharing

and risk diversification, better allocation of capital among investment opportunities and

potential for higher growth. Some studies also consider financial development as a

beneficial consequence of financial integration.

2.5.1 Risk sharing

Economic theory predicts that financial integration should have an effect on facilitating

risk sharing (Jappelli and Pagano, 2008). The integration into larger markets or even the

formation of larger markets is beneficial to both firms and financial markets and

institutions. According to Baele et al. (2004) financial integration provides additional

opportunities for firms and households to share financial risk and to smooth out

consumption inter-temporally.

Financial integration allows project owners with low initial capital to turn to an

intermediary that can mobilize savings so as to cover the initial costs. These avenues

indicate a strong link between financial institutions and economic growth (Levine, 1997).

The exploitation of economies-of-scale can allow firms, in particular those small and


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medium-sized ones that face credit constraints, to have better access to broader financial

or capital markets.

Risk-sharing opportunities make it possible to finance highly risky projects with

potentially very high returns, as the availability of risk-sharing opportunities enhances

financial markets and permits risk-averse investors to hedge against negative shocks.

Because financial markets and institutions can handle credit risk better, integration could

also remove certain forms of credit constraints faced by investors. The law of large

numbers guarantees less exposure to credit risk as the number of clients increases.

Individual risks could also be minimized by integrating into a larger market and, at the

same time, enhancing portfolio diversification.

Through the sharing of risk, financial integration leads to specialization in production

across the regions. Furthermore, financial integration promotes portfolio diversification

and the sharing of idiosyncratic risk across regions due to the availability of additional

financial instruments. It allows households to hold more diversified equity portfolios, and

in particular to diversify the portion of risk that arises from country-specific shocks.

Similarly, it allows banks to diversify their loan portfolios internationally. This

diversification should help Euro area households to buffer country-specific income

shocks, so that shocks to domestic income should not affect domestic consumption, but

be diversified away by borrowing or investing abroad (Jappelli and Pagano, 2008).

Kalemli-Ozcan et al. (2003) provide empirical evidence that sharing risk across regions

enhances specialization in production, thereby resulting in well-known benefits.

2.5.2 Improved capital allocation

It is a generally accepted view that greater financial integration should allow a better

allocation of capital (Levine, 2001). An integrated financial market removes all forms of

impediments to trading of financial assets and flow of capital, allowing for the efficient

allocation of financial resources for investments and production. In addition, investors

will be permitted to invest their funds wherever they believe these funds will be allocated

to the most productive uses. More productive investment opportunities will therefore


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become available to some or all investors and a reallocation of funds to the most

productive investment opportunities will take place (Baele et al., 2004).

Kalemli-Ozcan and Manganelli (2008) show that, by opening access to foreign markets,

financial integration will give agents a wider range of financing sources and investment

opportunities, and permits the creation of deeper and more liquid markets. This allows

more information to be pooled and processed more effectively, and capital to be allocated

in a more efficient way.

2.5.3 Economic growth

The theoretical literature proposes various mechanisms through which financial

integration may affect economic growth. In the neoclassical framework, all effects are

generated through capital flows. In the standard model, opening international capital

markets generates flows from capital-abundant towards capital-scarce countries, thereby

accelerating convergence (hence short term growth) in the poorer countries. In a more

sophisticated context, productivity may also increase since capital flows may relieve the

economy from credit constraints and thus allow agents to undertake more productive

investments (Bonfiglioli, 2008). Furthermore, in the standard neoclassical growth model,

financial integration enhances the functioning of domestic financial systems through the

intensification of competition and the importation of financial services, bringing about

positive growth effects (Levine, 2001).

An alternative view (Obstfeld, 1994a) suggests that international capital mobility may

affect productivity independently of investment, by promoting international risk

diversification, which induces more domestic risk taking in innovation activities, thereby

fostering growth. There is ample evidence in the literature that financial integration leads

to higher economic growth. Gianetti et al. (2002) demonstrate that, financial integration

facilitates access to investment opportunities and an increase in competition between

domestic and foreign financial institutions. This in turn leads to improved efficiency of

financial institutions as financial resources are released for productive activities. In

addition, financial integration leads to increased availability of intermediated investment

opportunities, and consequently higher economic growth. Authors also argue that, the


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integration process will increase competition within less developed regions and thereby

improve the efficiency of their financial systems by, for instance, reducing intermediation

costs.

2.5.4 Financial development

According to Hartmann et al. (2007) financial development can be understood as a

process of financial innovations, and institutional and organizational improvements in the

financial system. Combined, the process have the effect of reducing asymmetric

information, increasing the completeness of markets and contracting possibilities,

reducing transaction costs and increasing competition.

Jappelli and Pagano (2008) show that, the main channel through which the removal of

barriers to integration can spur domestic financial development is increased competition

with more sophisticated or lower-cost foreign intermediaries. This competitive pressure

drives down the cost of financial services for the firms and households of countries with

less developed financial systems, and thus expands local financial markets. In some

cases, the foreign entrants themselves may supply the additional financial services.

Direct penetration by foreign banks and cross-border acquisitions of intermediaries are

likely to erode local banks rents. If mergers bring banks closer to their efficient scale, the

process will also be associated with a decreasing cost of intermediation. Sharper

competition, possibly coupled with cost cutting, translates into more abundant credit

and/or lower interest rates. A second channel is through harmonization in national

regulations (accounting standards, security laws, bank supervision, corporate

governance), which the process of integration requires. To the extent that regulatory

harmonization promotes convergence to the best international standards, it will also

enhance domestic financial development and the entry of foreign financial intermediaries

in more backward countries.

The link between financial development and financial integration is of the utmost

importance, as there is strong evidence that financial development is linked with

economic growth (Baele et al., 2004).


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As described in Levine (1997), financial systems serve some basic purposes. Among

others, they (i) lower uncertainty by facilitating the trading, hedging, diversifying and

pooling of risk; (ii) allocate resources; and (iii) mobilize savings. These functions may

affect economic growth through capital and technological accumulation in an intuitive

way. However, while Levine (1997) recognizes the positive relationship between

economic growth and financial development, he is careful not to infer any causality.

Indeed, economic growth and financial development are so intertwined that it is difficult

to draw any firm conclusion with respect to causality. Nevertheless, recent research has

found evidence that financial development affects growth positively. Rousseau (2002)

finds empirical evidence that, financial development promotes investment and business

by reallocating capital. Trichet (2005) argues that financial integration fosters financial

development, which in turn creates potential for higher economic growth. Financial

integration enables the realization of economies of scale and increases the supply of

funds for investment opportunities. The actual integration process also stimulates

competition and the expansion of markets, thereby leading to further financial

development. In turn, financial development can result in a more efficient allocation of

capital as well as a reduction in the cost of capital.

2.6 Economic Integration Theories

We identified traditional economic integration or Preferential Trade Agreements (PTA)

theory that explains possible gains from trade and economic integration, or what is

commonly referred to as the static analysis of PTAs. New economic integration theory

that has evolved with changing economic conditions and trade environments, or what is

commonly referred to as the dynamic analysis of economic integration was also

discussed.

2.6.1 Traditional Economic Integration Theory

Studies discussing trade integration gains and explaining the theoretical implications of

preferential trade agreements are based on the pioneering study of Viner (1950).His

study, Viner's Traditional Customs Unions Theory was the first to identify concrete

criteria to distinguish between the possible advantages and disadvantages of economic

integration. Viner's so called "static analysis" of economic integration has divided


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possible effects of economic integration into the well known trade creation and trade

diversion effects.

Trade creation refers to the case when two or more countries enter into a trade agreement,

and trade shifts from a high-cost supplier member country to a low-cost supplier member

country in the union. Trade diversion may occur when imports are shifted from a low-

cost supplier of a non-member country of the union (third country) to a high-cost supplier

member country inside the union. This may be the case if common tariff after the union

protects the high cost supplier member country inside the union.

2.6.2 New Economic Integration Theory

Balassa (1962), and Cooper and Massell (1965) introduced dynamic effects into theanalysis of the welfare effects of economic integration, as a more efficient economic

reason or rationale behind the formation of customs unions or economic integration

schemes in general. Balassa's dynamic theory of economic integration proved that the

static analysis in terms of trade creation and trade diversion is simply not enough to fully

capture or analyze welfare gains from economic integration.

According to Allen (1963),Balassa (1962) listed the principle dynamic effects of

integration as large-scale economies, technological change, as well as the impact of

integration on market structure and competition, productivity growth, risk and

uncertainty, and investment activity. The same view is shared by Kreinin (1963).

According to Brada and Mendez (1988) integration is assumed to raise investment and

reduce risks. This can be explained by the fact that a larger market will raise the expected

return on investments and reduce uncertainty by enabling firms to lower their costs as a

result of increased economies of scale, and a bigger pool of consumers. Schiff and

Winters (1998) summarized the definition of the dynamic effects of economic integration

schemes as anything that affects the country's rate of economic growth over the medium

term.


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CHAPTER THREE: EMPIRICAL LITERATURE REVIEW

3.1 Introduction

This chapter presents a review of empirical literature on financial integration which

continues to attract considerable research effort among academicians. The discussion was

focused on empirical studies done in Asia, Africa and Europe as outlined below.

3.2 Studies in Asia

Hung and Cheung (1995) investigated the relationship between the major developed

markets of United States, United Kingdom and Japan with the emerging markets of

Malaysia, Thailand, Korea, Taiwan, Singapore and Hong Kong. Their major findings

were that, Singapore and Taiwan are co integrating with Japan while Hong Kong is cointegrating with the United States and the United Kingdom. There are no long run

equilibrium relationship between Malaysia, Thailand and Korea and the developed

markets of the United States, the United Kingdom and Japan. The relationship between

the developed and emerging markets also change over time, as shown by the differing co

movements between them in each of the sub-periods. Furthermore, an increasing

interdependence between most of the developed and emerging markets is observed after

the 1987 stock market crash. They concluded that, findings on the differential co-

movements between the developed and emerging markets can lead to further insights into

socioeconomic connections and provide useful information to both domestic and foreign

investors. Arising from this conclusion is the knowledge gap about the exact position on

the socioeconomic connections between domestic and foreign investors.

DeFusco et al. (1996) examined the long-run diversification potential of 13 emerging

capital markets. They applied the Johansen [18] and Johansen and Juselius [19] co

integration procedures to the U.S. and 13 emerging capital markets in three geographical

regions of the world using weekly data in the U.S. None of the three regions examined

possesses co integrated markets. They found that, these markets are not co integrated

between them, an indication that the correlation between returns from each market is

independent of the investment horizon return correlations. The conclusion of the study


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points out segmentation between U.S market and these emerging markets in the three

regions; an indication of the possible existence of international diversification benefits in

the short and long term across these markets. Assisted by these findings, one can carry

out a research to determine whether there is co integration among the thirteen emerging

equity markets in the Pacific Basin, Latin America and the Mediterranean regions.

Moosa and Bhatti (1997), sought to fill the gap of non-existence of empirical evidence on

the degree of integration between the goods and financial markets of Japan and six Asian

countriesby examining integration between the Japanese markets and those of six Asian

countriesHong Kong, Korea, Malaysia, the Philippines, Singapore and Taiwanover

the period 1980-1994. The study was conducted by testing uncovered interest parity

(UIP) and ex ante purchasing power parity (PPP).They found that, the results of testing

international parity conditions are affected not only by the length of the data sample or

the testing technique, but also by model specification. Their results are consistent with

and confirm the conventional wisdom that, there is a high degree of integration among

Asian goods and financial markets. The research gap emerging from this study, is

exploring of the issue of integration on the financial markets in isolation of the market for

goods and the use of conventional specifications in carrying out a similar study. One

could also consider a study on covered interest parity and compare the findings with

those on the uncovered interest parity.

Bhoi and Dhal (1998) aimed at empirically evaluating the extent of integration of Indias

financial markets in the post-liberalization period. The existing gap here was how far the

policy and institutional reforms initiatives undertaken in deregulating the financial sector,

had resulted in narrowing the inter-market divergences and achieved a reasonable degree

of market integration. Employing the co integration method, as well as causal and partial

adjustment analysis, , they found that there exists a fair degree of convergence of interest

rates among the short term markets - money, credit and gilt markets - the capital market

exhibits fairly isolated behaviour. The movement of various interest rates in uniform

directions, nevertheless shows an encouraging sign of the growing maturity of the

financial markets and their sensitivity to monetary policy. Additionally, there was a low


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conclusion drawn from this study is that, the US and the UK markets lead other

international markets both in the short and long term, despite the global financial crash of

October 1987. From this study we deduce the opportunity for further research that

captures the nature of linkages among international financial markets (not just stocks)

during the period after the 2008 global crisis. This could form some basis for a

comparative study on the October 1987 global financial crash and the 2008 global

financial crisis with the aim of establishing whether global financial crisis have an impact

on the interdependence of developed and emerging markets.

Cowen et al. (2006) in the IMF working paper conducted in Asia and pacific department

for the period 2001-2004, aimed at documenting trends and patterns in trade and financial

integration (which had been observed not long ago) at the regional level and explore

potential linkages, or the lack thereof, between the two. The study gap was the

association between finance and trade as established in previous studies. They found that,

correlation between trade and finance was positive but relatively small (compared to

OECD countries). The lack of time series data made it impossible for them to judge any

causal impact. In conclusion, they suggested that, East Asian financial and economic

integration is likely to increase over the future, as it is lower than in regions where the

barriers are lower, and the general trend is towards a reduction in barriers. The problem

in Asia in the context of this study which requires some research is the

identification/establishment of suitable regional vehicles in which to hold savings and

instruments in which they to invest.

3.3 Studies in Africa

Kenny and Moss, (1998) examined the emerging phenomenon of African stock

exchanges by evaluating the common economic criticisms of stock markets and the

political pitfalls involved in their operation. They wanted to understand whether - African

stock markets could work and their importance to the continents development. The study

methodology was the examination of debate and literature and therefore, no empirical

findings. It concludes that the positive economic effects of bourses on African economies

are far larger than any negative effects, and argues that the political costs can be

mitigated while political benefits can also be gained. Therefore, stock markets might not


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perform efficiently indeveloping countries and that it may not be feasible for all African

markets to promote stock markets given the huge costs and the poor financial structures.

Further research can be carried out to establish ways of reducing the costs and also

strengthening the financial structures to address the inefficiency problem identified in the

study above.

Mkenda (2001) investigated whether the East African Community, comprising of Kenya,

Tanzania and Uganda, constitutes an optimum currency area or not. The study employed

the Generalized Purchasing Power Parity method, and various criteria suggested by the

theory of Optimum Currency Areas. The findings of the study indicated that, while the

various indices calculated in the study based on the theory of Optimum Currency Areas

gave mixed verdicts, the Generalized Purchasing Power Parity (G-PPP) method supports

the formation of a currency union in the region. Using the G-PPP method, the study

established co integration between the real exchange rates in East Africa for the period

1981 to 1998, and even for the period 1990 to 1998. Overall the study concluded that, the

three countries tend to be affected by similar shocks. The study gap established from

these empirical findings is the determination of the cultural factors affecting/influencing

the establishment of a monetary union in East Africa.

Buigut and Valev (2005) set out to establish if the East African Community is a viable

Monetary Union and assess whether the political force driving the EAC towards a

monetary union had any economic basis .They did this by investigating the symmetric

nature of demand and supply shocks belying real GDP growth in partner states from

1980-2001as a precondition for forming an optimum currency area (OCA). The study

was meant to fill the existing gap of lack of empirical work/study on the much politically

advocated viable monetary union, using the Vector Autoregression (VAR) technique

Results from this study showed that, the speed of adjustment to shocks and the effect of

variability on real output (real GDP) appeared to be symmetric with the exception of

Uganda. In particular, Uganda experienced large shocks and adjustments were very slow

which could prove costly in a monetary union. Although the findings could not confirm a

viable monetary union at the time, they concluded that, the potential for a monetary union
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exists if there is deeper trade integration. The emphasis from this study is the importance

of a well-functioning common market. A new research gap that researchers can consider

filling, is the determinants of a well-functioning common market.

Kishor and Ssozi (2009) investigated whether the East African Community (EAC)

constitutes an optimum currency area (OCA) by estimating the degree and evolution of

business cycle synchronization between the EAC countries. They also investigated

whether the degree of business cycle synchronization has improved after signing of the

EAC treaty in 1999. The study aimed at contributed to the existing meager empirical

economic research about the viability of the EAC as a monetary union and not addressing

a specific research gap. The research methodology employed was that of unobserved

components model of structural shocks obtained from a structural VAR model and a time

varying parameter model to estimate the degree and evolution of business cycle

synchronization, respectively. Their results indicate that, the proportion of shocks that is

common across different countries is small, implying weak synchronization. However,

they also found that, the degree of synchronization has improved after signing of the

EAC treaty in 1999. The research gap established from their study is the lack of policy

measures that can enhance synchronization of business cycles to make the initiative a

success.

Opolot and Osoro (2009) aimed at investigating the feasibility of forming a monetary

union in the East African Community by examining the nature and extent of

synchronization of business cycles from 1981 to 2007, using the Christiano-Fitzgerald

(2003) version of the Band Pass filter. Further, they established the extent of co-

movement of business cycles using percentage standard deviations, autocorrelation

coefficients, cross-correlations, and contemporaneous correlations. The research gap was

similar to that of Buigut and Valev (2005) empirical feasibility of the East Africanmonetary union. Their findings suggest that, there is a general reduction in the volatility

of business fluctuations across the EAC countries and that, the extent of synchronization

seems to have improved since the late 1990s in all of the East African Countries, except

Burundi, attributing this trend to the relative macroeconomic stability that seemed to have

been obtaining in the region, then. In their study, they concluded that, although this


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general pattern suggests there is hope for a monetary union in the EAC, it calls for further

policy reforms to stabilize the national economies and the need for the EAC countries to

increase policy co-ordination in order to achieve the desired level of synchronization of

macroeconomic fluctuations. Future research can be carried out to determine sigma

convergence of the respective economies.

Opolot and Luvanda (2009) investigate the extent of macroeconomic convergence in the

East African Countries (EAC) using sigma convergence time. The findings were mixed

and incoherent, with convergence being established only for some countries and

indicators especially after 1995. With respect to nominal variables, there is evidence of

some partial convergence of monetary policy variables, while for fiscal policy variables,

there is absolutely no evidence of convergence. This study concluded that, there is need

for the EAC countries to increase policy harmonization and co-ordination so as to

establish a coherent policy environment in the region. More so, the EAC countries ought

to continue with the macroeconomic stabilization objective and integrate the

macroeconomic convergence benchmarks into the national planning and decision-making

frameworks so as to further enhance macroeconomic stability. The gap here, is a study to

establish effective monitoring and enforcement mechanisms for the EAC countries to

ensure strict observance of the macroeconomic convergence criteria and what policy

actions should be taken to ensure full convergence where partial convergence exists.

Buigut (2011) was motivated to fill the existing gap of lack of rigorous examination on

the prevailing state (by the time of the study) of monetary policy convergence for the

EAC. His study aimed at determining whether the member countries of the East African

community would form a successful monetary union based on the long-run behaviour of

nominal and real exchange rates, the monetary base and real GDP. The four variables

were each analyzed for co-movements among the five countries (Kenya, Uganda,

Tanzania, Rwanda and Burundi) using co integration technique. The findings of the study

showed partial convergence for the variables considered, suggesting there could be

substantial costs for the member countries from a fast-tracked process. The study

concluded that, the EAC countries need significant adjustments to align their monetary


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policies and to allow a period of monetary policy coordination to foster convergence that

will improve the chances of a sustainable currency union. The gap emanating from the

study is the determination of the current state of convergence of the EAC countries

policies, which remains unknown.

3.4 Studies in Europe

Baele et al. (2004) in a working paper series for the European Union bank investigated

the integration of corporate bond markets. Their aim was to determine whether

integration was progressing, stable or regressing. The research methodology was based

on cross-sectional regression analysis over the period 1998-2003, borrowing from the

exiting literature. In the analysis, the yield spread on a corporate bond, relative to a

benchmark government bond yield, was decomposed into a component common to all

and a component due to the corporate bonds coupon size, time to maturity, liquidity,

sector, and credit quality. In their findings, price-based integration measures suggest that,

the level and evolution of corporate bond yield spreads in the Euro area is to a large

extent determined by credit rating, and to a lesser extent by the common coupon,

maturity, liquidity and sector factors. The results also showed that once corrected for

pervasive riskthe country where a bond is issued has only marginal explanatory power

for the cross-section of corporate bond yield spreads . From the above findings, the study

concluded that, the corporate bond markets in the analyzed countries are reasonably

integrated with each other. But then, the researcher does not explicitly explain or state

what constitutes reasonable integration. In other words, is there a benchmark level of

integration which puts a demarcation between reasonable and unreasonable integration?

This is the research question (research gap for filling) that future research can answer.

Cappiello et al. (2006) in the working paper series of October from the European Central

Bank examined financial integration of the equity markets of the Euro area and the new

EU countries (Cyprus, Czech Republic, Estonia, Hungary, Latvia, Poland and Slovenia)

by carrying out the analysis of returns on equity market indices. The research issue for

solving in the working paper was the essence of monitoring the development of the

economic and financial links between these countries (which had exhibited interesting


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characteristics) and the Euro zone, bearing in mind that, they would eventually join the

European monetary union. They employed the factor model to analyse the variance of

market returns and regression analysis to determine the co-movement of returns over two

sample periods; pre convergence (before December 1999) and a convergence period

(after January 2000). Their results indicated the existence of closer links between the

three largest new member states, the Czech Republic, Hungary and Poland while for the

four smaller countries, Cyprus, Estonia, Latvia and Slovenia, they found a very low

degree of integration between themselves. However, Estonia and to a less extent Cyprus

show increased integration both with the Euro zone and the block of large economies.

These researchers, in support of the findings, argued that, institutional factors, the sheer

size of the economy, geographical distance and weak economic linkages with the Euro

area could be responsible for these results. The study concluded that, although all the

considered countries have experienced tremendous development in their stock markets,

their degrees of integration and speed of convergence with the Euro zone differ quite

markedly. By the foregoing, is it possible to achieve a similar objective using quantity-

based measures such as market capitalization? How about considering the period after the

global financial crisis? Would we arrive at the same findings? These are the questions

that seek for answers from future research.

Babetskii et al. (2007) focused on the empirical dimension of financial integration among

stock-exchange markets in four new European Union member states (Czech Republic,

Hungary, Poland, and Slovakia) in comparison with the Euro area. Their aim was to test

for the existence and determine the degree of the four states financial integration relative

to the euro currency union. Specifically, they were seeking to know whether there is

convergence of the above stock markets and if it really exists, how fast it was and how it

was changing over time.Being an empirical study, they applied harmonization analysis

(by means of standard and rolling correlation analysis) to outline the overall pattern of

integration, beta convergence (through the use of time series, panel, and state-space

techniques) to identify the speed of integration and sigma convergence to measure the

degree of integration.


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The findings of the study unambiguously point to the existence of beta-convergence of

the stock markets under review at the national and sectoral levels. In addition, shocks

dissipate at quite a high speed, infact less than half of a week and finally, the lack of

major impact of either EU enlargement or the announcement thereof on convergence.The

study concluded that, while evaluating the degree of stock market integration between

Euro-candidates and the Euro area, one should bear in mind that this is a relatively small

yet important segment of financial markets. The research gap in this study which future

researchers can consider filling is the extension of the objectives to a broader

examination of integration of the money, bond, and credit markets in the enlarged EU.

Abad et al. (2009) studied whether the introduction of the Euro had an impact on the

degree of integration of European government bond markets. They carried out a

comparative analysis of the degree of integration of government bond markets in two

groups of EU-15 countries: those that joined the European Monetary Union (EMU) and

those that stayed out. Using a sample spanning the period since the beginning of

Currency Union (1999) until June 2008, they applied news-based indicators on the

government bonds markets. They found that, apart from a set of world (regional)

instruments, a set of local instruments are also able to predict local bond returns. This

result suggests incomplete integration. They also found that, EMU and US government

bond markets present a low degree of integration. This finding serves as an indication

that, it is domestic rather than international risk factors that mostly drive the evolution of

government debt returns in EMU countries. Finally, the degree of integration with the US

and German bond markets clearly differs between Euro and non-Euro participating

countries; an indication that, these countries present a higher vulnerability to external risk

factors. Their study concluded that, government bond returns of EMU countries are more

influenced by Eurozone risk factors but the EMU countries are only partially integrated

with the German market since their markets are still segmented and present differences in

their market liquidity or default risk.

Avadanei (2010) studied corporate bond markets in an effort to know the economic

importance of the corporate bond market, the Euro implications regarding the growth of


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the market as well as the degree of the bond market integration. The aim of the study was

to draw out the lessons from the European monetary union by pointing out the

development of the corporate bond market. The article adopted a theoretical approach

and therefore does not employ any empirical research methodology. The discussion

points out that, the corporate bond market should operate in an efficient and liquid

manner due to its importance. On the implications of a common currency, it emerges that,

the varying benefits of corporate bond issuance is a reflection of the fact that institutional

and fiscal frameworks, as well as other historically determined characteristics that shape

financial structures, differ widely from one country to the next. Finally, the European

corporate bond markets convergence, showed an enhanced degree of financial

integration. His study concludes that, the existence of a mature and robust corporate bond

market, which works alongside a sound banking system, is an important feature of a well-

developed financial system. The existence of such a market appears to be positive for

economic development, as it allows corporations and banks to raise funds more quickly

and more flexible terms than would otherwise be possible.On the same conclusion, he

notes that the developments in Euro area corporate bond issuance can be explained by

movements in economic activity, the costs of issuance and mergers and acquisition

related activity. The latter reflects financing needs related to corporate restructuring,

which in turn may be partly related to the introduction of the single currency.

3.5Summary of Literature ReviewThis section presents (in table format) a summary of the literature review discussed above

in the same order. The summary outlines the name of the researcher (author), research

objectives, year of study, research methodology employed, the major findings of the

study and the emerging research gap(s).


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Summary of Literature Review

Author Study objectives Year of

Study

Methodology Major findings Research Gaps

1. Studies in Asia

Hung andCheung

To investigate therelationship between the

major developed markets

of United States, United

Kingdom and Japan with

the emerging markets of

Malaysia, Thailand, Korea,

Taiwan, Singapore and

Hong Kong

1995 Co integrationmethod

Singapore and Taiwan are cointegrating with Japan while

Hong Kong is co integrating

with the United States and the

United Kingdom. There are no

long run equilibrium

relationship between

Malaysia, Thailand and Korea

and the developed markets of

the United States, the United

Kingdom and Japan

Findings on thedifferential co-

movements between the

developed and emerging

markets can lead to

further insights into

socioeconomic

connections and provide

useful information to

both domestic and

foreign investors.

DeFusco et al To determine whether

there is linkage betweenthe American market and

thirteen emerging equity

markets in the Pacific

Basin, Latin America and

the Mediterranean regions

1996 Co integration

method

There is no co integration

between these markets; anindication that the correlation

between returns from each

market is independent of the

investment horizon return

correlations

The relationship among

the thirteen emergingequity markets in the

Pacific Basin, Latin

America and the

Mediterranean regions is

not addressed in the

study.


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Moosa and

Bhatti

Examined integration

between the Japanese

markets and those of six

Asian countries- Hong

Kong, Korea, Malaysia,

the Philippines, Singapore

and Taiwan-over theperiod 1980-1994.

1997 The study was

conducted by

testing uncovered

interest parity (UIP)

and ex ante

purchasing power

parity (PPP).

The results are consistent with

and confirm the conventional

wisdom that there is a high

degree of integration among

Asian goods and financial

markets.

Study does not address

the issue of integration

on the financial markets

isolation of the goods.

One could also consider

a study on covered

interest parity andcompare the findings

with those on the

uncovered interest

parity.

Bhoi and Dhal To empirically evaluate the

extent of integration of

Indias financial markets in

the post-liberalization

period.

1998 Co integration

method

There exists a fair degree of

convergence of interest rates

among the short term markets-

money, credit and gilt markets

- the capital market exhibits

fairly isolated behaviour.

Since the degree of

integration of domestic

market is dependent on

policy and institutional

setting facing such

market segments, the

ongoing financial reform

programme needs to be

accelerated to further

widen and deepen

various markets towards

achieving a higher

degree of convergence


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30

Kaminsky and

Schmukler

To examine the

characteristics of

international market

integration and the effects

of capital controls in theshort and long run.

2001 They applied band-

pass filter

techniques to data

from six emerging

economies duringthe 1990s.

Markets seem to be linked

more at longer horizons,

Equity prices seem to be more

connected internationally than

interest rates. They also findlittle evidence that controls

effectively segment domestic

markets from foreign markets

Medium term, bond

prices and interest rates,

were not considered in th

study

Masih and

Masih

To investigate whether

there exists dynamic causal

linkages amongst

international stock markets

2001 -Vector error-

correction modeling

- Level VAR

modeling

There exists significant

interdependencies between the

established OECD and the

emerging Asian Markets

There is need to carry ou

a similar study capturing

the period after the 2008

global crisis and compare

the findings

Cowen et al. To establish whether there

is an association between

trade and financial flows

among the East Asia

countries

2006 Correlation analysis Correlations are positive but

relatively small (compared to

OECD countries). One year

lags or leads have little effect

so it is not possible to judge

any causal impact.

Need for a study to

identify suitable regional

vehicles in which to hold

savings and instruments

in which they can invest


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2. Studies in Africa

Kenny

and

Moss

To examine the

emerging phenomenon

of African stock

exchanges by evaluating

the common economiccriticisms of stock

markets and the political

pitfalls involved in their

operation

1998 The examination of

debate and literature

A high proportion of countries in Sub-

Saharan Africa have a long history of

very low savings and deposit ratios,

and incomplete credit markets with

inefficient financial intermediation

There is a need to come up w

ways of reducing the costs an

also strengthening the financ

structures

Mkenda To investigate whether

the East African

Community, comprising

of Kenya, Tanzania, and

Uganda, constitutes an

optimum currency area

or not.

2001 Generalized

Purchasing Power

Parity method

The study established co integration

between the real exchange rates in East

Africa for the period 1981 to 1998, and

even for the period 1990 to 1998

Given that, there are differen

types of purchasing power

parity, there is a need to

consider a similar study usin

absolute and relative

purchasing power parity and

compare the findings.

Buigut

and

Valev

To establish if the East

African Community is a

viable Monetary Union

2005 Vector

Autoregression

(VAR) technique

The speed of adjustment to shocks and

the effect of variability on real output

(real GDP) appeared to be symmetric

with the exception of Uganda. In

particular, Uganda experienced large

shocks and adjustments were very slow

which could prove costly in a monetary

union.

The study only mentions abo

the speed of adjustment but

does not address how the

markets are able to adjust to

shocks


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33

Buigut To determine whether

the member countries

would form a successful

monetary union

2011 co integration

techniques

Partial convergence for the variables

considered, suggesting there could be

substantial costs for the member

countries from a fast-tracked process.

Further research can be

recommended to determine

what constitutes significant

adjustments for the EAC

countries to be able to align

their monetary policies and t

allow a period of monetarypolicy coordination to foster

convergence that will improv

the chances of a sustainable

currency union.

3.Studies in Europe

Baele et

al.

To investigate the

integration of corporate

bond markets

2004 Cross-sectional

regression

analysis

The corporate bond markets in the

analyzed countries are reasonably

integrated with each other

The researcher does not

explicitly explain or state wh

constitutes reasonable

integration

Cappiello

et al.

To examine financial

integration of the equity

markets of the Euro area

and the new EU

ountries (Cyprus, Czech

Republic, Estonia,

Hungary, Latvia, Poland

and Slovenia)

2006 Analysis of

variance and

regression

analysis

Increase in the degree of Existence of

closer links between the three largest

new member states, the Czech Republic,

Hungary and Poland while for the four

smaller countries, Cyprus, Estonia,

Latvia and Slovenia, they found a very

low degree of integration between

themselves

Exploring the possibility of

achieving a similar objective

using quantity- based measu

such as market capitalization


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Babetskii

et al.

To estimate financial

integration of the stock

markets of the Euro area

countries and the new

EU countries (Czech

Republic, Hungary,

Poland; Slovakia,Slovenia).

2007 Rolling

correlation

analysis

The existence of beta- convergence of

the stock markets under review at the

national and sectoral levels. In addition,

shocks dissipate at quite a high speed,

infact less than half of a week and

finally, the lack of major impact of either

EU enlargement or the announcementthereof on convergence

The extension of the objectiv

to a broader examination of

integration of the money, bo

and credit markets in the

enlarged EU.

Abad et

al.

To determine whether

the introduction of the

Euro had an impact on

the degree of integration

of European government

bond markets

2009 Comparative

analysis using

news-based

indicators

- They found that, apart from a set of

world (regional) instruments, a set of

local instruments are also able to predict

local bond returns

-EMU and US Government bond

markets present a low degree of

integration

Need for a similar study on t

European Equity markets an

compare the findings.

Avadanei To draw out the lessons

from the European

monetary union by

pointing out the

development of the

corporate bond market

2010 Theoretical

approach

-The varying benefits of corporate bond

issuance is a reflection of the fact that

institutional and fiscal frameworks, as

well as other historically determined

characteristics that shape financial

structures, differ widely from one

country to the next.

-The European corporate bond markets

convergence, showed an enhanced

degree of financial integration

The study does not tell us the

specific measures of a matur

and robust corporate bond

market. This calls for a more

rigorous study which

identifies/explains the

measures.


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3.6 Research Gap

On critically evaluating the existing literature, it has been observed that, most empirical

studies on financial integration stock markets, bond markets, money markets, credit

markets and the pension funds, have focused on the developed markets of Europe (Baele

et al. 2004, Cappiello et al. 2006, Babetskii et al.2007, Abad et al. 2009, Avadanei 2010)

and the emerging markets of Asia (Hung and Cheung, 1995, DeFusco et al. 1996, Moosa

and Bhatti 1997, Bhoi and Dhal 1998, Kaminsky and Schmukler 2001, Masih and Masih

2001, Cowen et al. 2006). The studies indicate evidence of increased beta convergence in

the financial marketsStocks, Bonds and Treasury bills.

However, the empirical studies on integration of the East African Community (EAC)

focus on the viability of a monetary union with a focus on business cycles and macro-

economic variablesExchange rate (real and nominal), GDP, fiscal policy variables and

monetary policy variables. For instance, Opolot and Osoro (2009) examined the nature

and extent of synchronization of business cycles from 1981 to 2000 and concluded that,

there is hope for a monetary union in the EAC, but further policy reforms would be

necessary to stabilize the national economies and the need for the EAC countries to

increase policy co-ordination in order to achieve the desired level of synchronization of

macroeconomic fluctuations. Buigut and Valev (2005) arrived at a similar conclusion.

They also found that, the degree of synchronization has improved after signing of the

EAC treaty in 1999. The research gap established from their study is the lack of policy

measures that can enhance synchronization of business cycles to make the initiative a

success. Mkenda (2001) and Buigut (2011) investigated the convergence of real and

nominal exchange rates. The findings of the study showed partial convergence for the

variables considered and concluded that, the three countries tend to be affected by similar

shocks and would therefore need significant adjustments to align their monetary policies

and to allow a period of monetary policy coordination to foster convergence that will

improve the chances of a sustainable currency union. The gap emanating from the study

is the determination of the current state of convergence of the EAC countries policies,

which remains unknown and also the determination of the cultural factors

affecting/influencing the establishment of a monetary union in East Africa.


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Clearly, no single study has discussed financial markets integration with specific focus on

the stocks and bonds markets.

3.7 Conclusion

As reviewed through the theoretical and empirical literature, it is evident that, academic

research on integration of the East African financial markets is lacking and therefore

objective one and two could not be achieved. This points to the existence of aknowledge

gap on the degree of beta convergence of the investment returns of stocks and bonds in

the East African Community financial markets.

3.8 Recommendations for Further Research

This study has laid a good platform for conducting further research which includes;

(i) Establishment of the findings on the differential co-movements between thedeveloped and emerging markets which can lead to further insights into

socioeconomic connections and provide useful information to both domestic and

foreign investors.

(ii) Need to research on further policy reforms to stabilize the national economies andalso determine ways of increasing policy co-ordination in order to achieve the

desired level of synchronization of macroeconomic fluctuations.

(iii) Further research can be recommended to determine what constitutes significantadjustments for the EAC countries to be able to align their monetary policies and

to allow a period of monetary policy coordination to foster convergence that will

improve the chances of a sustainable currency union.

(iv) Examining the financial integration of equity markets using quantity-basedmeasures such as market capitalization.


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Adelegan, O. Janet, (2008), Can Regional Cross-Listings Accelerate Stock Market

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Documents

Sample of Independent Paper - Isp