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The Home Bias and Capital Income Flows between Countries and Regions

  • Michael J. Artis
  • Mathias Hoffmann

This paper documents a marked increase in international consumption risk sharing throughout the recent globalization period. Unlike earlier studies that have found it difficult to document a consistent effect of financial globalization on international consumption comovements, we make use of the information implicit in the relative levels of consumption and output to measure long-run risk sharing among OECD countries and US federal states. We derive our empirical setup from a deliberately simplistic model in which countries can trade perpetual claims to each other's output (Shiller securities). Our framework allows us to distinguish between two channels of risk sharing: ex ante diversification that leads to income smoothing through capital income flows and ex-post consumption smoothing through savings and dissavings. The model successfully replicates the patterns of income and consumption smoothing observed in both U.S. state-level and international data. The increase in international consumption risk sharing is closely associated with the decline in international portfolio home bias. While capital income flows remain relatively limited as a channel of risk sharing at business cycle frequencies, we find that better international portfolio diversification has led to a considerable increase in capital income flows at medium and long horizons.

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Paper provided by Institute for Empirical Research in Economics - University of Zurich in its series IEW - Working Papers with number 316.

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Date of creation: Mar 2007
Date of revision:
Handle: RePEc:zur:iewwpx:316
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  1. Maurice Obstfeld, 2004. "External Adjustment," NBER Working Papers 10843, National Bureau of Economic Research, Inc.
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  14. Michael J. Artis & Mathias Hoffmann, 2007. "Financial Globalization, International Business Cycles, and Consumption Risk Sharing," IEW - Working Papers 346, Institute for Empirical Research in Economics - University of Zurich.
  15. 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.
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  17. Feldstein, Martin & Horioka, Charles, 1980. "Domestic Saving and International Capital Flows," Economic Journal, Royal Economic Society, vol. 90(358), pages 314-29, June.
  18. Lane, Philip R., 1999. "Do International Investment Income Flows Smooth Income?," CEPR Discussion Papers 2123, C.E.P.R. Discussion Papers.
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