Financial Markets and International Risk Sharing

Abstract

International risk sharing, Capital gains, Cross-border investment, Financial globalisation, Business cycle, F21, F30, G15,

The Euro Area Crisis: Need for a Supranational Fiscal Risk Sharing Mechanism?

“…In this context, the existence of risk sharing mechanisms for achieving income insurance and consumption smoothing is essential. While this role could be played by cross-border ownership of assets and liabilities and intra European credit (Atkeson and Bayoumi 1993;Schmitz 2010), as illustrated by Farhi and Werning (2012), market-based insurance tends to be suboptimal in currency unions as private agents do not internalize the macroeconomic stabilization effects of the portfolio choices. In addition, the recent financial crisis has shown that shocks hitting a member country's economy are quickly transmitted through the international financial system, and that credit markets tend to freeze up during downturns and, in some cases, contribute to amplify these shocks.…”

External balance sheets as countercyclical crisis buffers

“…Habib (2010), on the other hand, has claimed that cumulated investment income balances have a stronger influence than valuation changes on net external positions over time. See also Schmitz (2010Schmitz ( , 2013. He found that direct investment inflows into the crisis countries were more stable than other types of flows, and that U.S. manufacturing affiliates increased their exports in the wake of the crises more quickly than did domestic firms.…”

Financial Markets and International Risk Sharing in Emerging Market Economies

“…The empirical analysis of this paper follows the methods used by Schmitz () who focuses on a sample of industrial countries. In employing a capital market approach, we analyse the potential for hedging against domestic output and wealth fluctuations by means of cross‐country ownership of financial assets.…”

“…Because of the lack of these instruments, we use the following application as in Schmitz (): when domestic GDP grows faster, the domestic stock market performance should improve accordingly; that is, delivering higher capital gains for domestic and foreign investors. The benefit for foreign investors from this economic up‐swing is in the form of capital gains and dividend payments, which represents a ‘benign loss’ for the domestic economy.…”

“…In times of increasing international financial integration, both investment income flows and capital gains are channels that can potentially provide international risk sharing . For industrial countries, Lane () analysed the former channel using data on international investment positions, whereas Schmitz () investigated the latter (without finding evidence for income smoothing or hedging through these channels at business cycle frequencies). The capital gains channel is of growing relevance to EMEs with large equity shares in their portfolios which make most of their returns in the form of capital gains (thus, not affecting investment income flows) .…”