Does financial globalization promote risk sharing?

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.jdeveco.2008.09.001 Byline: M. Ayhan Kose (a), Eswar S. Prasad (b), Marco E. Terrones (a) Keywords: Financial globalization; Consumption risk sharing; Emerging markets Abstract: In theory, one of the main benefits of financial globalization is that it should allow for more efficient international risk sharing. In this paper, we provide an empirical evaluation of the patterns of risk sharing among different groups of countries and examine how international financial integration has affected the evolution of these patterns. Using a variety of empirical techniques, we conclude that there is at best a modest degree of international risk sharing, and certainly nowhere near the levels predicted by theory. In addition, only industrial countries have attained better risk sharing outcomes during the recent period of globalization. Developing countries have, by and large, been shut out of this benefit. Even emerging market economies, many of which have reduced capital controls and all of which have witnessed large increases in cross-border capital flows, have seen little change in their ability to share risk. We find that the composition of flows may help explain why emerging markets have not been able to realize this presumed benefit of financial globalization. In particular, our results suggest that portfolio debt, which had dominated the external liability stocks of most emerging markets until recently, is not conducive to risk sharing. Author Affiliation: (a) Research Department, International Monetary Fund, United States (b) Cornell University and Brookings Institution, United States Article History: Received 5 June 2007; Revised 29 August 2008; Accepted 2 September 2008 Article Note: (footnote) [star] Earlier versions of this paper were presented at the 2006 IMF Annual Research Conference, the January 2007 AEA meetings, the 2007 IMF-Cornell conference on 'New Perspectives on Financial Globalization,' workshops at the Bank of England, Inter-American Development Bank and the ECB-Bundesbank Joint Seminar Series. We would like to thank the editors, Gordon Hanson and Enrique Mendoza, and two anonymous referees for helpful comments that significantly improved the paper. We are grateful to our discussants, Jonathan Heathcote and Bent SA[cedilla]rensen, for their helpful suggestions. We also thank Karen Lewis, Fabrizio Perri and seminar participants for helpful comments. Dionysios Kaltis and Yusuke Tateno provided able research assistance. The views expressed in this paper are those of the authors and do not necessarily reflect the views of the IMF or IMF policy.