International consumption risk sharing studies have largely ignored their models' counterfactual implications for asset returns although these returns incorporate direct market measures of risk. In this paper, we modify a canonical risk-sharing model to generate more plausible asset return behavior and then consider the effects on welfare gains. Matching the mean and variance of equity returns and the risk-free rate requires persistent consumption risk, leading to three main findings: (1) risk-sharing gains decrease as the ability to diversify persistent consumption risk decreases; (2) the international correlation of equity returns is high relative to the correlation of consumption and dividends, implying low diversification potential for persistent consumption risk; and (3) increasing persistent consumption risk reduces the gains. Taken together, our findings suggest that asset returns imply more international risk sharing than previously thought.

This paper estimates an empirical nonstationary panel regression model that tests long-run consumption risk sharing across a sample of OECD and emerging market (EM) countries. This is in contrast to the existing literature on consumption risk sharing, which is mainly about risks at business cycle frequency. Since our methodology focuses on identifying cointegrating relationships while allowing for arbitrary short-run dynamics, we can obtain a consistent estimate of long-run risk sharing while disregarding any short-run nuisance factors. Our results show that long-run risk sharing in OECD countries increased more than that in EM countries during the past two decades.

Complete financial markets allow countries to share their consumption risks internationally, thereby creating welfare gains through lower volatility of aggregate consumption. This paper empirically looks at international consumption risk sharing and its determinants in a panel of 120 countries from 1970 to 2014. Contrary to some previous studies, I show that financial liberalization and financial integration has a significantly positive impact on international consumption risk sharing in poorer developing countries, whereas in emerging market countries only capital account openness has an impact. Moreover, there is some evidence that high income inequality or a high share of low income individuals reduces consumption smoothing in less developed countries. Lack of financial reforms, a lower degree of financial integration and higher inequality can thus partly explain why the degree of risk sharing is lower in developing countries than in advanced economies.

Recent research in international business cycles based upon complete markets has found that international consumption correlations are lower than predicted by the standard risk-sharing implications of these models. In this paper, I use regression tests to ask whether two different types of explanations can help explain this result. First, I consider whether non-separabilities between tradeables and non-tradeable leisure or goods can explain the puzzle. Surprisingly, non-separabilities explain only a tiny fraction of the variation in tradeables consumption across countries. Furthermore, risk-sharing in tradeables is rejected. Second, I examine the effects of capital market restrictions on aggregate consumption risk-sharing by countries. While rejections of risk-sharing are stronger for countries facing more severe capital market restrictions, risk-sharing is still rejected for the unrestricted group of countries. Therefore, risk-sharing does not appear to be resolved by either explanation alone. However, when I allow for both non-separabilities and certain market restrictions, risk-sharing among unrestricted countries is not rejected. This evidence suggests that a combination of these two effects may be necessary to explain consumption risk-sharing across countries.

Though theory suggests financial globalization should improve international risk sharing, empirical support has been limited. We develop a simple welfare-based measure that captures how far countries are from the ideal of perfect risk sharing. We then take it to data and find international risk sharing has, indeed, improved during globalization. Improved risk sharing comes mostly from the convergence in rates of consumption growth among countries rather than from synchronization of consumption at the business cycle frequency. Our finding explains why many existing measures fail to detect improved risk sharing-they focus only on risk sharing at the business cycle frequency.