Financial Markets and International Risk Sharing in Emerging Market Economies

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In light of rapidly increasing foreign equity liability positions of emerging market economies, we test for a necessary condition of international risk sharing, namely for systematic patterns between idiosyncratic output fluctuations and financial market developments. Panel analysis of 22 emerging market economies shows strong evidence for pro-cyclicality of capital gains on domestic stock markets both over short and medium term horizons. This implies that domestic output fluctuations can be hedged through cross-border ownership of financial markets.