Working Paper: CEPR ID: DP4697
Authors: Michael J. Artis; Mathias Hoffmann
Abstract: Consumption based measures of international risk sharing seem to defy the effects of more than two decades of ongoing financial globalization. We put forward an explanation of this puzzle: under incomplete risk sharing and if there are several sources of risk, consumption based measures of risk sharing will also be a function of the structure of business cycles, i.e. their degree of synchronization and persistence. We argue that permanent and transitory shocks to output constitute such qualitatively different sources of risk. Using OECD data, we then illustrate that countries have indeed become more insured against permanent shocks, in line with the ever better integration of financial markets. Basic measures of risk sharing have however not picked up this change because globalization has also affected the structure of business cycles. In particular, our results are consistent with the observation recently made by several authors that the globalization period has seen the emergence of less volatile and internationally more synchronized business cycles among industrialized countries.
Keywords: capital flows; consumption risk sharing; home bias; international business cycles; regional business cycles
JEL Codes: C23; E21; F36
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| financial globalization (F30) | improved insurance against permanent shocks (G52) |
| business cycle structure (E32) | consumption risk sharing (E21) |
| permanent shocks (E32) | consumption risk sharing (E21) |
| transitory shocks (E32) | consumption risk sharing (E21) |
| synchronized international business cycles (F44) | enhanced risk sharing (G52) |
| changes in business cycle structures (E32) | lack of consumption risk sharing (E21) |