This paper uses a panel VAR model to improve upon the existing literature on interregional risk sharing channels (e.g. Asdrubali, Sorensen and Yosha, 1996) in several respects. First, it endogenizes the output process within a multi-equation framework, capturing the dynamic feedback between output and various risk sharing channels. Second, in contrast to previous research's analysis of static risk sharing in the presence of exogenous output shocks, it uses impulse response functions to trace the role of each risk sharing channel over time, in the presence of different structural shocks (temporary vs. persistent and output vs. risk sharing channels). Third, the paper extends the risk sharing channels typically analyzed, by considering the consumption smoothing role of changes in the nominal exchange rate and relative commodity prices across regions. The empirical method is applied to the U.S. states, 23 OECD countries, and 15 countries in the European Union from 1960 to 1990. Regarding the dynamic responses of each risk sharing channel to exogenous output shocks, the results suggest that the dynamics are substantially different among different channels. First, most capital market smoothing is achieved on impact while fiscal smoothing is achieved over time. Second, credit market plays a positive role on impact, but a negative role later. Regarding the substitutability of channels, first, fiscal smoothing is fully substituted by credit market channel in the U.S. while only half of capital market smoothing is substituted in OECD and EU countries. Second, fiscal smoothing is not substituted by any other channels in the U.S. while half of fiscal smoothing is substituted by credit market smoothing in the OECD and EU countries. The results also suggest that nominal and real exchange rate movements are very important in analyzing international risk sharing in OECD and EU countries.
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