Financial Frictions and Asymmetric International Risk Sharing

International risk sharing in OECD countries weakens during domestic recessions, when its role is most needed. Instead, no significant changes emerge during boom periods or in relation to the global business cycle. The asymmetry in the risk sharing response to cyclical fluctuations is driven mainly by dissmoothing effects in the capital market channel and the credit market channel. Specifically, interest payments to abroad and credit constraints of households increase during domestic recessions, limiting the smoothing role of risk sharing channels. However, countries with more internationally integrated financial markets and corporate disclosure can mitigate the dis-smoothing effects of these two channels and thus the asymmetry in international risk sharing. These findings contribute to rationalise heterogeneous results in the literature on the impact of globalisation and of financial frictions on international risk sharing. From an analytical viewpoint, they caution against assessments of international risk sharing over time which do not take the business cycle into account. From a policy perspective, they establish that, contrary to part of the literature on financial frictions, financial integration and corporate disclosure do affect international risk sharing during recessions. Since our results carry over to EU countries, they support the pursuit of the Capital Markets Union and further elimination of financial barriers to the completion of the Single Market. They also call for a more active role of counter-cyclical fiscal policy: during a recession, when a negative (positive) output shock hits, net government savings should fall (rise) along with net private savings, in order to preserve consumption stability.