Edited by Klaus Liebscher, Josef Christl, Peter Mooslechner and Doris Ritzberger-Grünwald
Chapter 22: International risk sharing in Europe: has anything changed?
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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