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The Economic Potential of a Larger Europe

The Economic Potential of a Larger Europe

Edited by Klaus Liebscher, Josef Christl, Peter Mooslechner and Doris Ritzberger-Grünwald

The Economic Potential of a Larger Europe gives insights into past, present and future issues related to the ongoing EU enlargement process. Providing a unique forum for debate and a multiplicity of views and experiences from both high-profile academics and those who engage with enlargement on an implementation level, this book covers a wide range of topics that are key to a successful transition and integration process and thus to the provision of a prosperous growth environment within a larger Europe. Special attention is paid to monetary integration, notably entry into ERM II, on which representatives of the national central banks involved present their views.

Chapter 22: International risk sharing in Europe: has anything changed?

Gabriel Moser, Wolfgang Pointner and Johann Scharler


Gabriel Moser, Wolfgang Pointner and Johann Scharler1 1. INTRODUCTION It is well known that developed financial markets allow investors to efficiently pool idiosyncratic risk. Agents can protect themselves against stochastic fluctuations in their incomes through trading in assets with appropriate payoff structures. Open and integrated financial markets allow them to choose from a larger set of assets and to pool risks across borders. However, the usual finding in the literature is that international risk sharing is rather limited.2 Backus et al. (1992) demonstrate that crosscountry consumption correlations are too low to be consistent with a model characterized by complete markets and perfect capital mobility. In addition, French and Poterba (1991) report a large home bias in equity holdings and consequently only a small degree of international diversification. Moreover, various authors have empirically tested for risk sharing using consumption data and find that the implications of complete market models are largely rejected.3 In particular, a common result is that the crosscountry correlations of output growth rates are higher than those of consumption growth rates, which indicates that the opportunities for international risk sharing are not fully exploited. Moreover, consumption is usually found to react to country specific shocks, which is inconsistent with perfect risk sharing. However, the ongoing process of globalization and financial market integration has increased the amount of international financial transactions. Tesar and Werner (1998) present some evidence that the home bias, although still substantial, has somewhat declined over time. Thus, one might expect risk sharing...

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