International Risk Sharing Research Articles

A wavelet analysis of international risk-sharing

I analyze the perfect risk-sharing condition in the time–frequency domain using wavelets. Some countries engage more in risk-sharing at specific frequencies while others at all frequencies, but only for a short period of time. Increasing degree of risk-sharing over time is visible only for the UK and the US and only at low frequencies.

International Risk Sharing with Market Segmentation

We study the effect of an asymmetric environment on risk sharing. In our model, entrepreneurs consider undertaking risky projects in the real sector as well as selling part of their projects to investors. To capture the idea of an asymmetric environment, the returns on the alternative risk-free investment are allowed to differ between the entrepreneurs and the investors, i.e., agents have different opportunity costs of participating in the risky projects. We first show that the presence of asymmetric options establishes links between the risk-free and risky sectors as well as between the real and financial sectors. In particular, an asymmetric environment implies that the amount of risk sharing depends on the risk-free rates and the expected return of the risky project. Moreover, the level of real investment also depends on the risk-free rates. Second, we show how different risk-free rates may encourage or discourage risk sharing, and even prevent risk sharing altogether.

Is Increasing Financial Integration Related to Improved International Risk Sharing?

In order to answer the question whether more integrated financial markets are characterized by less international risk sharing we focus on the long-term evolutions of the intensively discussed anomalies of the equity home bias, used as indicator for financial integration, and the international risk sharing in consumption. Using panel-data regressions for 21 OECD countries from 1980 to 2010, we show that a less than average amount of equity home bias, e.g. higher than average amount of international income flows, is associated with more international risk sharing. Much of the increase in international asset positions came during the recent globalization period. More generally, by measuring financial integration by the index of the equity home bias, our results indicate that more financial integration goes hand-in-hand with more internationally shared risk. Our results are robust across countries and time.

Has Globalization Improved International Risk Sharing?

AbstractIn this paper, we study the dynamics of international consumption risk sharing among the G‐7 countries. Based on the dynamic conditional correlation model due to Engle (2002), we construct a time‐varying, consumption‐based measure of risk sharing. We find that the exposure to country‐specific shocks has evolved heterogeneously across the G‐7 countries and that risk sharing varies procyclically with the output gap. This dependence on the business cycle is especially pronounced in countries where credit constraints are relatively binding.

International Risk Sharing and Commodity Prices

We extend the Cole and Obstfeld model in a number of directions to more accurately assess the terms of trade channel. Two crucial theoretical extensions are: to allow multiple producers of each primary commodity and to allow for incomplete specialization.We find that the negative correlation between a relative commodity price and its production level needed to provide the endogenous terms of trade risk sharing in the Cole and Obstfeld model, is largely inoperative in the real world.

Exchange Rates and International Risk Sharing

Recent research in international finance has equated changes in real exchange rates with differences between the marginal utility growths of representative agents in different economies. The asset market view of exchange rates, encapsulated in this equation, has been used to gain insights into exchange rate determination, foreign exchange risk premia, and international risk sharing. We argue that, in fact, this equation is of limited usefulness. By itself, the asset market view does not identify the economic mechanism that determines the exchange rate. It only holds under complete markets, and even then, it does not generally allow us to identify the marginal utility growths of distinct agents. Moreover, if we allow for incomplete asset markets, measures of agents' marginal utility growths, and international risk sharing, cannot be based on asset market and exchange rate data alone. Instead, we argue that in order to explain how exchange rates are determined, it is necessary to make specific assumptions about preferences, goods market frictions, the assets agents can trade, and the nature of endowments or production.

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International Risk Sharing and Globalization

The main research question of this empirical work is whether or not globalization, in its various forms, has had an impact upon international risk sharing. The empirical literature so far has only investigated on one aspect of globalization: economic and financial integration. By decomposing globalization in its economic, political and social aspects, and using a standard framework of consumption insurance tests to gauge the extent of risk sharing among countries, we obtain some interesting results. One of the main findings is that economic and social integration help better cope with idiosyncratic risk, but also that without political integration this might result in an increasing exposure to systemic (uninsurable) risk.

Traded and Nontraded Goods Prices, and International Risk Sharing: An Empirical Investigation

Dar cuenta de la clara evidencia de una limitada diversificacion del riesgo internacional es un reto importante para los modelos de economia abierta, sobre todo cuando estos se adoptan en el analisis de politicas que puedan resultar afectadas por imperfecciones en los mercados financieros. Fundamental en la literatura es la evidencia, contraria a la eficiencia, que el consumo es relativamente alto en los paises en los que su precio relativo internacional (el tipo de cambio real) tambien es alto. En este papel reconsideramos la relacion entre los diferenciales de consumo entre paises y los tipos de cambio reales, descomponiendola en dos factores que reflejan, respectivamente, los precios de los bienes comerciables y no comerciables. Documentamos que, en un patron comun entre los paises de la OCDE, los dos componentes contribuyen a la falta general de diversificacion del riesgo. El factor de precios de bienes comerciables juega un papel dominante en la explicacion de las desviaciones de la eficiencia. Relacionamos estos resultados con dos mecanismos propuestos por la literatura para reconciliar los modelos de economia abierta con los datos. Un mecanismo actua a traves de fuertes efectos Balassa-Samuelson sobre los precios de los bienes no comerciables debidos a aumentos de productividad en el sector de comerciables, con un debil efecto compensatorio de los precios de bienes comerciables. El otro mecanismo actua a traves de efectos riqueza endogenos que aprecian los precios de bienes no comerciables y especialmente los precios de comerciables debido a un aumento de la demanda del consumo interno.

Financial Markets and International Risk Sharing in Emerging Market Economies

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.

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The International Risk-Sharing Puzzle is at Business-Cycle and Lower Frequency

We decompose the correlation between relative consumption and the real exchange rate into its dynamic components at different frequencies. Using multivariate spectral analysis techniques we show that, at odds with a high degree of risk-sharing, in most OECD countries the dynamic correlation tends to be quite negative, and significantly so, at frequencies lower than two years - the appropriate frequencies for assessing the performance of international business cycle models. Theoretically, we show that the dynamic correlation over different frequencies predicted by standard open-economy models is the sum of two terms: a term constant across frequencies, which can be negative when uninsurable risk is large; and a term variable across frequencies, which in bond economies is necessarily positive, reflecting the insurance that intertemporal trade provides against forecastable contingencies. Numerical analysis suggests that leading mechanisms proposed by the literature to account for the puzzle are consistent with the evidence across the spectrum.

International Investment Positions and Risk Sharing: An Empirical Analysis on the Coordinated Portfolio Investment Survey

By using data from nine waves of the IMF Coordinated Portfolio Investment Survey, we explore the determinants of bilateral portfolio investments and their dynamics. The main goal of our analysis is that of understanding whether a diversifi cation motive can be found, among the various determinants. We introduce a new diversifi cation variable given by the correlation between the idiosyncratic components of GDP growth and first take into account unobserved heterogeneity by means of a country pair-fi xed e ffect, panel estimation relaxing the more restrictive double fixed eff ects model due to Lane and Milesi-Ferretti (REStat 90:538-549, 2008). We find strong evidence that a diversifi cation motive is relevant to explain bilateral portfolio holdings. The same results cannot be obtained from cross section estimations as in previous literature. It also turns out that investing in stocks of less synchronised partner economies does not bring about a lot of income smoothing, as one might have expected.

Ramsey policies in a small open economy with sticky prices and capital

This paper analyzes jointly optimal fiscal and monetary policies in a small open economy with capital and sticky prices. We allow for trade in consumption goods under perfect international risk-sharing. We consider balanced-budget fiscal policies where authorities use distortionary taxes on labor and capital together with monetary policy using the nominal interest rate. First, as long as a symmetric equilibrium is considered, the steady state in an open economy is isomorphic to that of a closed economy. Second, sticky prices’ allocations are almost indistinguishable from flexible prices allocations both in open and closed economies. Third, the open economy dimension delivers results that are qualitatively similar to those of a closed economy but with significant quantitative changes. Tax rates are both more volatile and more persistent to undo the distortions implied by terms of trade fluctuations.

International risk-sharing and currency unions: The CFA zones

This paper explores income and consumption smoothing patterns among the member countries of each of the CFA zones—the CEMAC1 and the WAEMU2—during the period 1980–2005. I find that for the CEMAC, about 24 per cent of shocks to GDP are smoothed through the standard channels (i.e. capital market, credit market and remittances). On the other hand, I find that 66 per cent of shocks are smoothed via foreign aid from France, and 6 per cent via central bank contributions, while reserves pooling provides no shock smoothing. For the WAEMU, I find that only 22 per cent of shocks are smoothed through the standard channels, while about 50 per cent are smoothed via foreign aid from France, 5 per cent via central bank contributions, and no smoothing via reserves pooling. Copyright © 2010 John Wiley & Sons, Ltd.

Channels of international risk-sharing: capital gains versus income flows

Global financial integration unlocks a huge potential for international risk sharing. We examine the degree to which international equity holdings act as a risk sharing device in industrial and emerging economies. We split equity returns into investment income (dividend distribution) and capital gains to investigate which of the two channels delivers the largest potential for risk sharing. Our evidence suggests that net capital gains are a more potent channel of risk sharing. They behave in a countercyclical way, that is they tend to be positive (negative) when the domestic economy is growing more slowly (rapidly) than the rest of the world. Countries with more countercyclical net capital gains experience improved consumption risk sharing. The empirical analysis furthermore suggests that these risk sharing properties of net capital gains have increased through time, in particular in the 1990s and early-2000s, on the back of a declining equity home bias and financial market deepening.

Trade-off Between International and Domestic Risk Sharing in the Presence of Sovereign Risk

This paper analyzes how sovereign risk affects government's ability to smooth domestic risk when policy tools imperfectly discriminate foreign and domestic agents. The government cannot choose to pay differently foreign and domestic bond holders; however it can imperfectly discriminate against foreign investors by reducing overall debt payments and lowering domestic tax burden accordingly. This paper shows that, in an overlapping generations economy with privately observable idiosyncratic risk, this distortion results in excessive consumption inequality in the cross-section of domestic agents and excessive consumption volatility in the time series. Opening the capital account enables international risk sharing, but also introduces this government's distortion. Its overall effect on consumption risk is therefore ambiguous.

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A Portfolio Model of Capital Flows to Emerging Markets

Since the crises of the late 1990's, most emerging market economies have built up substantial positive holdings of US dollar treasury bills, while at the same time experiencing a boom in FDI capital inflows. This paper develops a DSGE model of the interaction between an emerging market economy and an advanced economy which incorporates two-way capital flows between the economies. The novel aspect of the paper is to make use of new methods for analyzing portfolio choice in DSGE models. We compare a range of alternative financial market structures, in each case computing equilibrium portfolios. We find that an asymmetric configuration where the emerging economy holds nominal bonds and issues claims on capital (FDI) can achieve a considerable degree of international risk-sharing. This risk-sharing can be enhanced by a more stable monetary policy in the advanced economy.

International Risk Sharing During the Globalization Era

Though theory suggests financial globalization should improve international risk sharing, empirical support has been limited. We develop a simple welfare-based measure that captures how far countries are from the ideal of perfect risk sharing. We then take it to data and find international risk sharing has, indeed, improved during globalization. Improved risk sharing comes mostly from the convergence in rates of consumption growth among countries rather than from synchronization of consumption at the business cycle frequency. Our finding explains why many existing measures fail to detect improved risk sharing-they focus only on risk sharing at the business cycle frequency.