A new measure of international risk sharing

Abstract

Empirical anomalies are found with two conventional approaches to measuring extent of international risk sharing, a process in which country-specific income shocks being smoothed out via cross-border asset transactions. Regression approach, by running a regression of idiosyncratic consumption growth on idiosyncratic income growth, suggests that developing countries are better at sharing income risks than more-developed countries. Correlation approach, by comparing consumption growth correlation with income growth correlation, leads to the consumption correlation puzzle, and when being extended to less advanced countries shows that consumption correlation is even smaller than income correlation for advanced countries than for other lessdeveloped counterparts. Our proposed single-country risk-sharing model shows that a country where productivity shocks driving income fluctuations would have a larger regression coefficient, i.e. a lower degree of risk sharing Extending the model to a multi-country version shows that both global permanent and transitory income shocks would drive comovement of consumption growth across countries under perfect risk sharing condition. The fact that consumption only reacts to permanent shocks suggests that consumption correlation puzzle could be due to the relatively dominant role played by global transitory income shocks. Estimates of the new risk-sharing measure embedded in the single-country model show that advanced countries are on average able to share 86 percent of income risks while emerging and developing countries can eliminate 68 percent and 48 percent, respectively. © Serials Publications Pvt. Ltd.