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We show that international home bias in debt and equity holdings has declined during the late 1990s at the same time as international risk sharing has increased. Using panel data estimations, we demonstrate that less home bias is associated with more international risk sharing. Alternatively, we show that the higher the level of foreign assets to Gross Domestic Product, the more risk sharing is obtained. This indicates that lack of risk sharing and international financial integration are closely related empirical phenomena.JEL Classification: F36

We provide empirical evidence that risk sharing enhances specialization in production. To the best of our knowledge, this well-established and important theoretical proposition has not been tested before. Our empirical procedure is summarized as follows. First, we construct a measure of specialization in production, and calculate an index of specialization for each of the European Community EC and non-EC OECD countries, U.S. states, Canadian provinces, Japanese prefectures, Latin American countries, and regions of Italy, Spain, and the United Kingdom. Then, we estimate the degree of capital market integration a measure of risk sharing within each of these groups of regions: the EC countries, the non-EC OECD countries, the United States, Canada, Japan, Italy, Spain, and the United Kingdom and rely on another author's estimate for Latin America. Finally, w e perform a regression of the specialization index on the degree of risk sharing, controlling for relevant economic variables. We nd a positive and signi cant relation between the degree of specialization of individual members of a group of countries, provinces, states, or prefectures, and the amount of risk that is shared within the group. We perform regressions using variables such as shareholder rights and the size of the nancial sector relative to GDP as instruments for the amount o f i n ter-regional risk sharing. These regressions con rm that risk sharing|facilitated by a f a vorable legal environment and a developed nancial system|is a direct causal determinant of industrial specialization. JEL Classi cation: F15, F2, F36, F43