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Financial globalization, domestic financial freedom and risk sharing across countries

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  • Li, Zhongda
  • Liu, Lu

Abstract

In theory, integrated global financial markets facilitate the diversification of consumption risks by decoupling consumption volatility from country-specific income fluctuations. However, the degree of risk sharing across countries is rather limited despite the recent waves of financial globalization. In this paper, we investigate an alternative avenue through which agents smooth their consumption volatility. We have noticed that apart from financial openness, domestic financial freedom is also a critical factor that determines a country’s ability to insure against consumption risks. To motivate our analysis, we first develop a modified model of intranational and international risk sharing. We then examine the relative importance of domestic financial freedom and financial globalization in shaping the risk sharing outcomes using a large cross-country panel dataset. Our empirical findings suggest that for most countries in the world, domestic financial environment matters more in stabilizing consumption fluctuations than financial integration. We also show that agents are willing to give up a large amount of their consumption to achieve complete intranational or international risk sharing.

Suggested Citation

  • Li, Zhongda & Liu, Lu, 2018. "Financial globalization, domestic financial freedom and risk sharing across countries," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 55(C), pages 151-169.
  • Handle: RePEc:eee:intfin:v:55:y:2018:i:c:p:151-169
    DOI: 10.1016/j.intfin.2018.04.003
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    More about this item

    Keywords

    Consumption risk sharing; Financial globalization; Domestic financial freedom; Welfare gains;

    JEL classification:

    • F15 - International Economics - - Trade - - - Economic Integration
    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration

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