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Financial Integration and Consumption Smoothing

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Abstract

We present a new empirical strategy for testing if financial integration improves risk sharing opportunities and consumption smoothing. Our test is based on a decomposition of the variance of consumption growth into a component that depends on the variance of permanent income shocks and one that depends on the variance of transitory shocks. We then test if the process of financial market integration and liberalization brought about by the introduction of the euro has made consumption less sensitive to income shocks in Italy. The paper makes a significant contribution also from a methodological point of view. We use panel data on income to identify non parametrically a time series of the variances of the income shocks. We then rely on repeated cross-sections of consumption and income to identify the degree of smoothing with respect to income shocks, and test if it has declined after the introduction of the euro. Our procedure does not require that consumption and income are available in the same panel data. It can therefore be applied in all countries in which repeated cross-sectional consumption data can be combined with panel data on income.

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Bibliographic Info

Paper provided by Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy in its series CSEF Working Papers with number 200.

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Date of creation: 14 Jul 2008
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Publication status: Published in The Economic Journal, Vol. 121(553), pp. 621–903
Handle: RePEc:sef:csefwp:200

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Keywords: Sharing; Consumption Smoothing; Financial Market Integration;

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Cited by:
  1. Guillermo Yañez & Mariel Siravegna & Guillermo Larrain, 2009. "Intégration aux marchés financiers internationaux et lissage de la consommation : observations récentes en Amérique latine," Revue d'Économie Financière, Programme National Persée, vol. 95(2), pages 87-108.
  2. Tullio Jappelli & Luigi Pistaferri, 2010. "Does Consumption Inequality Track Income Inequality in Italy?," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 13(1), pages 133-153, January.
  3. Heshmati, Almas & Rudolf, Robert, 2013. "Income vs. Consumption Inequality in South Korea: Evaluating Stochastic Dominance Rankings by Various Household Attributes," IZA Discussion Papers 7731, Institute for the Study of Labor (IZA).
  4. Chiara Binelli & Orazio Attanasio, 2010. "Mexico in the 1990s: the Main Cross-Sectional Facts," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 13(1), pages 238-264, January.
  5. Guglielmo Maria Caporale & Michael Donadelli & Alessia Varani, 2014. "International Capital Markets Structure, Preferences and Puzzles: The US-China Case," CESifo Working Paper Series 4669, CESifo Group Munich.
  6. Donadelli, Michael & Paradiso, Antonio, 2014. "Does financial integration affect real exchange rate volatility and cross-country equity market returns correlation?," The North American Journal of Economics and Finance, Elsevier, vol. 28(C), pages 206-220.
  7. Philip R. Lane, 2008. "EMU and Financial Integration," The Institute for International Integration Studies Discussion Paper Series iiisdp272, IIIS.

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