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

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Author Info
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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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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Related research
Keywords: Capital Market Integration Euro Portfolio Bias Income Smoothing

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Find related papers by JEL classification:
G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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  1. Sorensen, Bent E. & Wu, Yi-Tsung & Yosha, Oved & Zhu, Yu, 2007. "Home bias and international risk sharing: Twin puzzles separated at birth," Journal of International Money and Finance, Elsevier, vol. 26(4), pages 587-605, June. [Downloadable!] (restricted)
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  2. Philip Lane & Gian Maria Milesi-Ferretti, 2005. "A Global Perspective on External Positions," The Institute for International Integration Studies Discussion Paper Series iiisdp079, IIIS. [Downloadable!]
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  3. 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. [Downloadable!] (restricted)
  4. Pagano, Marco & von Thadden, Ernst-Ludwig, 2004. "The European Bond Markets Under EMU," CEPR Discussion Papers 4779, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  5. Sachs, Jeffrey & Sala-i-Martin, Xavier, 1992. "Fiscal Federalism and Optimum Currency Areas: Evidence for Europe from the United States," CEPR Discussion Papers 632, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  6. 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. [Downloadable!]
  7. 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(2000-1), pages 1-60. [Downloadable!]
  8. Warnock, Francis E., 2002. "Home bias and high turnover reconsidered," Journal of International Money and Finance, Elsevier, vol. 21(6), pages 795-805, November. [Downloadable!] (restricted)
  9. 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. [Downloadable!] (restricted)
  10. Mélitz, Jacques & Zumer, Frédéric, 1999. "Interregional and International Risk Sharing and Lessons for EMU," CEPR Discussion Papers 2154, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  11. Sorensen, Bent E. & Yosha, Oved, 1998. "International risk sharing and European monetary unification," Journal of International Economics, Elsevier, vol. 45(2), pages 211-238, August. [Downloadable!] (restricted)
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  12. repec:tcd:wpaper:tep16 is not listed on IDEAS
  13. Kristin J. Forbes & Menzie D. Chinn, 2004. "A Decomposition of Global Linkages in Financial Markets Over Time," The Review of Economics and Statistics, MIT Press, vol. 86(3), pages 705-722, 09. [Downloadable!] (restricted)
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