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International dynamic risk sharing

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  • Giuseppe Cavaliere

    ()

  • Luca Fanelli

    ()

  • Attilio Gardini

    ()

Abstract

In this paper we examine the formal implications of international risk sharing among a set of countries in the presence of market frictions and forward-looking behaviour. We show that if frictions prevent consumption to adjust instantaneously to its optimal long run level, consumption streams in the countries belonging to the risk sharing pool change over time according to a dynamic disequilibrium model which can be nested within an error-correcting vector autoregressive process. Econometric methods for testing the restrictions imposed by the theory at both short and long horizons are proposed and discussed. The empirical analysis of a set of core European countries suggest that consumption data do not seem to contrast neither with the existence of risk sharing against permanent income fluctuations and integrated capital markets, nor with a gradual and interrelated process of adjustment towards the equilibrium. The apparent lack of risk sharing in Europe documented in earlier works might depend not only on the misspecification of the short run dynamics of consumption, but also on the relatively low speed of adjustment toward the equilibrium.

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Bibliographic Info

Paper provided by Department of Statistics, University of Bologna in its series Quaderni di Dipartimento with number 1.

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Date of creation: 2006
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Handle: RePEc:bot:quadip:1

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Keywords: Adjustment costs; Consumption risk sharing; Cointegrated; VAR models; Financial market integration; Market frictions.;

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References

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  1. Karen K. Lewis, 1999. "Trying to Explain Home Bias in Equities and Consumption," Journal of Economic Literature, American Economic Association, vol. 37(2), pages 571-608, June.
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  3. Benigno, Gianluca & Thoenissen, Christoph, 2006. "Consumption and Real Exchange Rates with Incomplete Markets and Non-Traded Goods," CEPR Discussion Papers, C.E.P.R. Discussion Papers 5580, C.E.P.R. Discussion Papers.
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  5. Asdrubali, Pierfederico & Kim, Soyoung, 2004. "Dynamic risksharing in the United States and Europe," Journal of Monetary Economics, Elsevier, Elsevier, vol. 51(4), pages 809-836, May.
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  7. Serena Ng & Pierre Perron, 1997. "Lag Length Selection and the Construction of Unit Root Tests with Good Size and Power," Boston College Working Papers in Economics, Boston College Department of Economics 369, Boston College Department of Economics, revised 01 Sep 2000.
  8. Kollmann, R., 1992. "Consumption, Real Exchange Rates and the Structure of International Asset Markets," Cahiers de recherche, Centre interuniversitaire de recherche en économie quantitative, CIREQ 9232, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
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  11. Jeffrey C. Fuhrer & Michael W. Klein, 1998. "Risky Habits: On Risk Sharing, Habit Formation, and the Interpretation of International Consumption Correlations," NBER Working Papers 6735, National Bureau of Economic Research, Inc.
  12. Domenico Giannone & Lucrezia Reichlin, 2005. "Trends and cycles in the Euro Area: how much heterogeneity and should we worry about it?," Macroeconomics, EconWPA 0511016, EconWPA.
  13. Apte, Prakash & Sercu, Piet & Uppal, Raman, 2004. "The exchange rate and purchasing power parity: extending the theory and tests," Journal of International Money and Finance, Elsevier, Elsevier, vol. 23(4), pages 553-571, June.
  14. David K. Backus & Patrick J. Kehoe & Finn E. Kydland, 1991. "International real business cycles," Staff Report, Federal Reserve Bank of Minneapolis 146, Federal Reserve Bank of Minneapolis.
  15. Luca Fanelli, 2006. "Dynamic adjustment cost models with forward-looking behaviour," Econometrics Journal, Royal Economic Society, Royal Economic Society, vol. 9(1), pages 23-47, 03.
  16. Binder,M. & Pesaran,H.M., 1995. "Multivariate Rational Expectations Models and Macroeconomic Modelling: A Review and Some New Results," Cambridge Working Papers in Economics 9415, Faculty of Economics, University of Cambridge.
  17. Giuseppe Cavaliere & Luca Fanelli & Attilio Gardini, 2006. "International dynamic risk sharing," Quaderni di Dipartimento, Department of Statistics, University of Bologna 1, Department of Statistics, University of Bologna.
  18. Kollmann, Robert, 1996. "Incomplete asset markets and the cross-country consumption correlation puzzle," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 20(5), pages 945-961, May.
  19. Maurice Obstfeld., 1993. "Are Industrial-Country Consumption Risks Globally Diversified?," Center for International and Development Economics Research (CIDER) Working Papers, University of California at Berkeley C93-014, University of California at Berkeley.
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  22. Cavaliere, Giuseppe & Fanelli, Luca & Gardini, Attilio, 2006. "Regional consumption dynamics and risk sharing in Italy," International Review of Economics & Finance, Elsevier, Elsevier, vol. 15(4), pages 525-542.
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Citations

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Cited by:
  1. Giuseppe Cavaliere & Luca Fanelli & Attilio Gardini, 2008. "International dynamic risk sharing," Journal of Applied Econometrics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 23(1), pages 1-16.
  2. Cavaliere, Giuseppe & Taylor, A. M. Robert & Trenkler, Carsten, 2013. "Bootstrap Co-integration Rank Testing: The Effect of Bias-Correcting Parameter Estimates," Working Papers 32993, University of Mannheim, Department of Economics.
  3. Giuseppe Cavaliere & Luca Fanelli & Attilio Gardini, 2009. "Consumption risk sharing and adjustment costs," Economics Bulletin, AccessEcon, vol. 29(2), pages 1117-1126.
  4. Franchi, Massimo & Paruolo, Paolo, 2011. "A characterization of vector autoregressive processes with common cyclical features," Journal of Econometrics, Elsevier, Elsevier, vol. 163(1), pages 105-117, July.

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