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International Portfolio Allocation and Income Smoothing: Evidence from Recent Changes in Euro Region

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  • Balli, Faruk
  • Louis, Rosmy J.
  • Osman, Mohammad
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    Abstract

    In this paper, we make two contributions to the literature. First, we construct a new measurement to capture income smoothing effectively. Second, we present new empirical evidence on the linkages between international asset trading and income smoothing. We use factor income inflows instead of the commonly used net factor income and arrive at results, among others, similar to previous studies in the literature: (a) risk sharing and equity portfolio home bias are strongly correlated for EU members; and (b) Specialization in output plays a significant role in income smoothing. Our findings also confirm that the increased level of economic integration witnessed in the Euro area as a result of the monetary union fosters output specialization across EU members and leads to asymmetric output fluctuations. Cross-border financial assets’ trading within the Euro Area, though smaller in comparison to the overall OECD block, serves as a shock absorber as factor income flows to smooth domestic consumption and income. However, although we have observed a decrease in home bias for OECD members, we could not find any evidence of higher income smoothing as a result.

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    Bibliographic Info

    Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 10160.

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    Date of creation: 02 Aug 2008
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    Handle: RePEc:pra:mprapa:10160

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    Keywords: Capital Market Integration; Euro Portfolio Bias; Income Smoothing;

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    References

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    1. Faruk, Balli, 2006. "New Patterns in International Portfolio Allocation and Income Smoothing," MPRA Paper 10121, University Library of Munich, Germany, revised 14 Aug 2008.
    2. Xavier Sala-i-Martin & Jeffrey Sachs, 1991. "Fiscal Federalism and Optimum Currency Areas: Evidence for Europe From the United States," NBER Working Papers 3855, National Bureau of Economic Research, Inc.
    3. Philip Lane & Gian Maria Milesi-Ferreti, 2005. "A Global Perspective on External Positions," Trinity Economics Papers tep16, Trinity College Dublin, Department of Economics.
    4. Sorensen, Bent E & Wu, Yi-Tsung & Yosha, Oved & Zhu, Yu, 2005. "Home Bias and International Risk Sharing: Twin Puzzles Separated at Birth," CEPR Discussion Papers 5113, C.E.P.R. Discussion Papers.
    5. Sorensen, B-E & Yosha, O, 1996. "International Risk Sharing and European Monetary Unification," Papers 40-96, Tel Aviv.
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    7. Warnock, Francis E., 2002. "Home bias and high turnover reconsidered," Journal of International Money and Finance, Elsevier, vol. 21(6), pages 795-805, November.
    8. Balli, Faruk, 2008. "Spillover Effects on Government Bond Yields in Euro Zone. Does Full Financial Integration Exist in European Government Bond Markets?," MPRA Paper 10162, University Library of Munich, Germany.
    9. Jacques Mélitz & Frédéric Zumer, 1999. "Interregional and International Risk Sharing and Lessons for EMU," Sciences Po publications n°2154, Sciences Po.
    10. Marco Pagano, 2004. "The European Bond Markets under EMU," Oxford Review of Economic Policy, Oxford University Press, vol. 20(4), pages 531-554, Winter.
    11. repec:tcd:wpaper:tep16 is not listed on IDEAS
    12. Brian M. Doyle & Jon Faust, 2005. "Breaks in the Variability and Comovement of G-7 Economic Growth," The Review of Economics and Statistics, MIT Press, vol. 87(4), pages 721-740, November.
    13. 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.
    14. Balli, Faruk & Sorensen, Bent E., 2007. "Risk Sharing among OECD and EU Countries: The Role of Capital Gains, Capital Income, Transfers, and Saving," MPRA Paper 10223, University Library of Munich, Germany.
    15. Robert Anderton & Filippo di Mauro & Fabio Moneta, 2004. "Understanding the impact of the external dimension on the euro area - trade, capital flows and other international macroeconomic linkages," Occasional Paper Series 12, European Central Bank.
    16. Kalemli-Ozcan, Sebnem & Sorensen, Bent E. & Yosha, Oved, 2001. "Economic integration, industrial specialization, and the asymmetry of macroeconomic fluctuations," Journal of International Economics, Elsevier, vol. 55(1), pages 107-137, October.
    17. George A. Akerlof & William T. Dickens & George L. Perry, 2000. "Near-Rational Wage and Price Setting and the Long-Run Phillips Curve," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 31(1), pages 1-60.
    18. Philip Lane & Gian Maria Milesi-Ferretti, 2006. "Exchange Rates and External Adjustment: Does Financial Globalization Matter?," The Institute for International Integration Studies Discussion Paper Series iiisdp129, IIIS.
    19. Giofré, Maela/M., 2008. "EMU Effects on Stock Markets: From Home Bias to Euro Bias," MPRA Paper 13926, University Library of Munich, Germany.
    20. Tesar, Linda L. & Werner, Ingrid M., 1995. "Home bias and high turnover," Journal of International Money and Finance, Elsevier, vol. 14(4), pages 467-492, August.
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