On International Consumption Risk Sharing, Financial Integration and Financial Development

This paper investigates the empirical link between international consumption risk sharing, financial integration, and financial development for a group of twenty-nine developed and developing countries in the G7, the Euro area and the OECD. We first compute the degree of consumption risk sharing of these countries using an average risk sharing measure. We then relate the average risk sharing measure of these countries to their level of financial integration and financial development. We find that (i) the average consumption risk sharing in the Euro area is higher than those in the G-7 and the OECD, and (ii) a higher degree of international consumption risk sharing is associated with a greater degree of financial integration and a lower level of financial development. Based on these results, we argue that more financially integrated countries with more developed financial markets are better able and less in need to insure themselves against idiosyncratic income shocks. Inclusion of per capita income, output risk and trade openness as additional control variables reduces the effects of financial integration and financial development on consumption risk sharing. Holding financial integration and financial development equal, countries in the Euro area engage in significantly more consumption risk sharing than the ones in the G7 and the OECD.