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Risk sharing, finance and institutions in international portfolios

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Author Info
Marcel Fratzscher () (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.)
Jean Imbs () (HEC Lausanne, Dept of Economics, Lausanne 1015 Switzerland.)

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Abstract

We show that international consumption risk sharing is significantly improved by capital flows, especially portfolio investment. Concomitantly, we show that poor institutions hamper risk sharing, but to an extent that decreases with openness. In particular, risk sharing is prevalent even among economies with poor institutions, provided they are open to international markets. This is consistent with the view that the prospect of retaliation may deter expropriation of foreign capital, even in institutional environments where it is possible. This deterrent is anticipated by investors, who act to diversify risk. By contrast, capital flows headed for closed economies with poor institutions are designed and constrained so as to limit the cost incurred in case of expropriation, and thus achieve little risk sharing. Finally, we show this non-linearity continues to be present in the determinants of international capital flows themselves. Institutions are crucial in attracting capital for closed economies, but are barely relevant in open ones. JEL Classification: F21, F30, G15.

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Paper provided by European Central Bank in its series Working Paper Series with number 826.

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Length: 46 pages
Date of creation: Oct 2007
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Handle: RePEc:ecb:ecbwps:20070826

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Related research
Keywords: Risk sharing; Diversification; Portfolio Choice; Financial Integration; Cross-border Investment; Foreign Direct Investment; Bank Loans; Portfolio Investment.;

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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Pot Erik & Flesch János & Peeters Ronald & Vermeulen Dries, 2009. "Dynamic Competition with Consumer Inertia," Research Memoranda 037, Maastricht : METEOR, Maastricht Research School of Economics of Technology and Organization. [Downloadable!]
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