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Common correlated effects and international risk sharing

  • Peter Fuleky

    ()

    (UHERO and Department of Economics, University of Hawaii at Manoa)

  • L Ventura

    (Department of Economics and Law, Sapienza, University of Rome)

  • Qianxue Zhao

    (Department of Economics, University of Hawaii at Manoa)

International risk sharing has been among the most actively researched areas of macroeconomics for the last two decades. Empirical contributions in this field make extensive use of so called "consumption insurance" tests evaluating the extent to which idiosyncratic shocks in income get transferred to consumption. A prerequisite of such a test is the isolation of country specific variation in the data. We show that the cross-sectional demeaning technique frequently used in the literature is in general inadequate to eliminate global factors from a panel data set, and can lead to misleading inference. We argue that international risk sharing tests should instead be based on a method that more reliably deals with global factors. We claim and illustrate in our empirical application that the fairly simple common correlated e ects estimator for cross-sectionally dependent panels introduced by Pesaran (2006), and Kapetanios et al. (2010) is a tool that satisfies this requirement.

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File URL: http://www.economics.hawaii.edu/research/workingpapers/WP_13-4.pdf
File Function: First version, 2013
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Paper provided by University of Hawaii at Manoa, Department of Economics in its series Working Papers with number 201304.

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Length: 17 pages
Date of creation: Mar 2013
Date of revision:
Handle: RePEc:hai:wpaper:201304
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  1. Sul, Donggyu, 2009. "Panel unit root tests under cross section dependence with recursive mean adjustment," Economics Letters, Elsevier, vol. 105(1), pages 123-126, October.
  2. Giannone, Domenico & Reichlin, Lucrezia, 2006. "Trends and cycles in the euro area: how much heterogeneity and should we worry about it?," Working Paper Series 0595, European Central Bank.
  3. Jalan, Jyotsna & Ravallion, Martin, 1997. "Are the poor less well-insured? Evidence on vulnerability to income risk in rural China," Policy Research Working Paper Series 1863, The World Bank.
  4. G. Kapetanios & M. Hashem Pesaran & T. Yamagata, 2010. "Panels with nonstationary multifactor error structures," Post-Print hal-00768190, HAL.
  5. Hendry, David F., 1995. "Dynamic Econometrics," OUP Catalogue, Oxford University Press, number 9780198283164, March.
  6. Michael J. Artis & Mathias Hoffmann, 2007. "The Home Bias and Capital Income Flows between Countries and Regions," IEW - Working Papers 316, Institute for Empirical Research in Economics - University of Zurich.
  7. Pesaran, M.H., 2003. "A Simple Panel Unit Root Test in the Presence of Cross Section Dependence," Cambridge Working Papers in Economics 0346, Faculty of Economics, University of Cambridge.
  8. Banerjee, A. & Marcellino, M. & Osbat, C., 2000. "Some Cautions on the Use of Panel Methods for Integrated Series of Macro-economic Data," Economics Working Papers eco2000/20, European University Institute.
  9. Pesaran, M.H., 2004. "‘General Diagnostic Tests for Cross Section Dependence in Panels’," Cambridge Working Papers in Economics 0435, Faculty of Economics, University of Cambridge.
  10. Asdrubali, Pierfederico & Sorensen, Bent E & Yosha, Oved, 1996. "Channels of Interstate Risk Sharing: United States 1963-1990," The Quarterly Journal of Economics, MIT Press, vol. 111(4), pages 1081-1110, November.
  11. Robert J. Shiller, 1993. "Aggregate Income Risks and Hedging Mechanisms," NBER Working Papers 4396, National Bureau of Economic Research, Inc.
  12. Pesaran, M.H. & Yamagata. T., 2005. "Testing Slope Homogeneity in Large Panels," Cambridge Working Papers in Economics 0513, Faculty of Economics, University of Cambridge.
  13. Sørensen, 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.
  14. Sascha O. Becker & Mathias Hoffmann, 2003. "Intra-and International Risk-Sharing in the Short Run and the Long Run," CESifo Working Paper Series 1111, CESifo Group Munich.
  15. Eleonora Pierucci & Luigi Ventura, 2010. "Risk Sharing: A Long Run Issue?," Open Economies Review, Springer, vol. 21(5), pages 705-730, November.
  16. Grimard, Franque, 1997. "Household consumption smoothing through ethnic ties: evidence from Cote d'Ivoire," Journal of Development Economics, Elsevier, vol. 53(2), pages 391-422, August.
  17. Mace, Barbara J, 1991. "Full Insurance in the Presence of Aggregate Uncertainty," Journal of Political Economy, University of Chicago Press, vol. 99(5), pages 928-56, October.
  18. M. Hashem Pesaran, 2006. "Estimation and Inference in Large Heterogeneous Panels with a Multifactor Error Structure," Econometrica, Econometric Society, vol. 74(4), pages 967-1012, 07.
  19. 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.
  20. Michael J. Artis & Mathias Hoffmann, 2011. "The Home Bias, Capital Income Flows and Improved Long-Term Consumption Risk Sharing between Industrialized Countries," International Finance, Wiley Blackwell, vol. 14(3), pages 481-505, December.
  21. Markus Leibrecht & Johann Scharler, 2008. "Reconsidering Consumption Risk Sharing among OECD Countries: Some Evidence Based on Panel Cointegration," Open Economies Review, Springer, vol. 19(4), pages 493-505, September.
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