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What Can Explain the Apparent Lack of International Consumption Risk Sharing?

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  • Karen K. Lewis
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    Abstract

    Recent research in international business cycles based upon complete markets has found that international consumption correlations are lower than predicted by the standard risk-sharing implications of these models. In this paper, I use regression tests to ask whether two different types of explanations can help explain this result. First, I consider whether non-separabilities between tradeables and non-tradeable leisure or goods can explain the puzzle. Surprisingly, non-separabilities explain only a tiny fraction of the variation in tradeables consumption across countries. Furthermore, risk-sharing in tradeables is rejected. Second, I examine the effects of capital market restrictions on aggregate consumption risk-sharing by countries. While rejections of risk-sharing are stronger for countries facing more severe capital market restrictions, risk-sharing is still rejected for the unrestricted group of countries. Therefore, risk-sharing does not appear to be resolved by either explanation alone. However, when I allow for both non-separabilities and certain market restrictions, risk-sharing among unrestricted countries is not rejected. This evidence suggests that a combination of these two effects may be necessary to explain consumption risk-sharing across countries.

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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5203.

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    Date of creation: Aug 1995
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    Publication status: published as Journal of Political Economy, April 1996, vol.104, pp.267-297.
    Handle: RePEc:nbr:nberwo:5203

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    1. Obstfeld, Maurice, 1994. "Risk-Taking, Global Diversification, and Growth," American Economic Review, American Economic Association, vol. 84(5), pages 1310-29, December.
    2. Domenico Cuoco & Jaksa Cvitanic, . "Optimal Consumption Choices for a "Large" Investor," Rodney L. White Center for Financial Research Working Papers 4-96, Wharton School Rodney L. White Center for Financial Research.
    3. Marianne Baxter & Mario J. Crucini, 1994. "Business Cycles and the Asset Structure of Foreign Trade," NBER Working Papers 4975, National Bureau of Economic Research, Inc.
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    6. Fabio Canova & Morten O. Ravn, 1993. "International consumption risk sharing," Economics Working Papers 135, Department of Economics and Business, Universitat Pompeu Fabra, revised Jun 1995.
    7. Devereux, Michael B. & Gregory, Allan W. & Smith, Gregor W., 1992. "Realistic cross-country consumption correlations in a two-country, equilibrium, business cycle model," Journal of International Money and Finance, Elsevier, vol. 11(1), pages 3-16, February.
    8. John Heaton & Deborah Lucas, 1993. "Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing," NBER Working Papers 4249, National Bureau of Economic Research, Inc.
    9. Cochrane, John H, 1991. "A Simple Test of Consumption Insurance," Journal of Political Economy, University of Chicago Press, vol. 99(5), pages 957-76, October.
    10. Heaton, John & Lucas, Deborah, 1995. "The importance of investor heterogeneity and financial market imperfections for the behavior of asset prices," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 42(1), pages 1-32, June.
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    12. Atkinson, Anthony B & Micklewright, John, 1991. "Unemployment Compensation and Labor Market Transitions: A Critical Review," Journal of Economic Literature, American Economic Association, vol. 29(4), pages 1679-1727, December.
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    14. Stockman, Alan C & Tesar, Linda L, 1995. "Tastes and Technology in a Two-Country Model of the Business Cycle: Explaining International Comovements," American Economic Review, American Economic Association, vol. 85(1), pages 168-85, March.
    15. Maurice Obstfeld, 1986. "How Integrated are World Capital Markets? Some New Tests," NBER Working Papers 2075, National Bureau of Economic Research, Inc.
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    Cited by:
    1. Kraay, Aart & Ventura, Jaume, 1995. "Trade and fluctuations," Policy Research Working Paper Series 1560, The World Bank.
    2. Eijffinger, Sylvester & Wagner, Wolf, 2010. "Incentive problems and the pattern of international risk sharing," Journal of International Money and Finance, Elsevier, vol. 29(7), pages 1206-1225, November.

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