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Does Financial Globalization Promote Risk Sharing?

JOURNAL OF DEVELOPMENT ECONOMICS 2009 WRITTEN BY: M. AYHAN KOSE, ESWAR S. PRASAD, AND MARCO E. TERRONES PRESENTED BY: BENJAMIN GARCIA AND BRIAN GIERA

Outline
1.

Introduction
1. 2. 3.

Proposed benefits Previous literature Contributions to the literature

2. Dataset 3. Theory

4. Regression Results
5. Conclusion 1. Areas for future research

Introduction

The goal of this paper is to study the impact of financial globalization on the degree of international consumption risk sharing for a large set of industrial and developing countries.

Proposed Benefits
One of the main benefits from financial globalization

is that it allows countries to smooth consumption in the face of country-specific fluctuations in output growth.
It should generate welfare gains by: Reducing the volatility of aggregate consumption Delinking fluctuations in national consumption and output

Previous Literature
Degree of risk sharing is rather limited, even among

advanced industrial economies (Obstfeld, 1994, 1995; Lewis, 1996, 1999; Sorensen and Yosha, 1998; Moser et al., 2004; Bai and Zhang, 2005) Risk sharing has increased during the recent period of globalization (Sorenson et al., 2007; Artis and Hoffman, 2006; Giannone and Reichlin, 2006) How about for non-industrial countries?

Contributions to the Literature


Extend the analysis to a large group of emerging markets and other developing countries. 2. Examine changes over time in the degree of risk sharing across different groups of countries and attempt to relate those to changes in the degree of financial openness. 3. Provide a careful evaluation of the alternative measures of risk sharing using various empirical approaches.
1.

Also focuses on different measures of financial integration

Dataset
The authors have data from: the Penn World Tables 6.2 the World Banks World Development Indicators Annual data from 1960-2004 for 69 countries: 21 industrial countries 21 emerging markets 27 developing counties

The data covers: Per capita real GDP Real private consumption Real public consumption

Dataset (continued)
Measure of capital account openness: 1. Binary variable labeled restrictive or non-restrictive by the IMF in their Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER) 2. Binary variable based on the dates of their equity market liberalization (Bekaert et al., 2005) 3. Continuous measure based off AREAER data (Chinn and Ito, 2006) 4. Continuous measure based off AREAER data (Edwards, 2005) 5. De facto measures gross stocks of external assets and liabilities as ratios of GDP

Theory

Predictions of the effects of risk sharing are based on

dynamics of correlations between domestic consumption and world output/consumption


Models with complete markets predict that the

correlation of a countrys consumption growth with the growth of world output should be higher than its correlation with that countrys output growth

Theory (part 2)

Industrial countries appear to have higher

correlations of consumption and output with the corresponding world aggregates

These correlations are typically much lower for developing countries

For EMEs, these correlations with world aggregates

has declined slightly during the globalization period.

Theory (part 3)
Here is our regression specification:

With perfect risk sharing, the difference between

consumption growth rates on the LHS should be equal to 0

This implies that the regression (RHS of eq. 3) should yield a coefficient of 0

Theory (part 4)
The basic risk sharing equation:

The difference between the national and common

world component of each variable captures the idiosyncratic (country specific) fluctuations in that variable In an ideal theoretical world, one with complete financial markets and perfect risk sharing, our coefficient t, is equal to 0.

Smaller t means a greater degree of risk sharing

Questions/Comments?