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

  • Balli, Faruk
  • Louis, Rosmy J.
  • Osman, Mohammad
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    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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    File URL: https://mpra.ub.uni-muenchen.de/10160/1/MPRA_paper_10160.pdf
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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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    1. Kristin J. Forbes & Menzie D. Chinn, 2003. "A Decomposition of Global Linkages in Financial Markets Over Time," NBER Working Papers 9555, National Bureau of Economic Research, Inc.
    2. Melitz, Jacques & Zumer, Frederic, 1999. "Interregional and international risk-sharing and lessons for EMU," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 51(1), pages 149-188, December.
    3. Faruk, Balli, 2006. "New Patterns in International Portfolio Allocation and Income Smoothing," MPRA Paper 10121, University Library of Munich, Germany, revised 14 Aug 2008.
    4. 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.
    5. 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.
    6. Lane, Philip R. & Milesi-Ferretti, Gian Maria, 2005. "A Global Perspective on External Positions," CEPR Discussion Papers 5234, C.E.P.R. Discussion Papers.
    7. 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.
    8. Brian M. Doyle & Jon Faust, 2003. "Breaks in the variability and co-movement of G-7 economic growth," International Finance Discussion Papers 786, Board of Governors of the Federal Reserve System (U.S.).
    9. 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.
    10. 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.
    11. repec:tcd:wpaper:tep16 is not listed on IDEAS
    12. 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.
    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. Giofré, Maela/M., 2008. "EMU Effects on Stock Markets: From Home Bias to Euro Bias," MPRA Paper 13926, University Library of Munich, Germany.
    15. Pagano, Marco & von Thadden, Ernst-Ludwig, 2004. "The European Bond Markets Under EMU," CEPR Discussion Papers 4779, C.E.P.R. Discussion Papers.
    16. 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.
    17. Warnock, Francis E., 2002. "Home bias and high turnover reconsidered," Journal of International Money and Finance, Elsevier, vol. 21(6), pages 795-805, November.
    18. 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.
    19. 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.
    20. 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.
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