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.

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.

This paper examines the extent of consumption risk sharing for a group of 50 high-income and developing countries. The analysis is based on the empirical implementation of a model of partial consumption insurance whose parameters have the natural interpretation of coefficients of partial risk sharing even when the 0 hypothesis of perfect risk sharing is rejected. The estimation results show that high-income countries exhibit higher degrees of risk sharing than developing countries, and that the gap between the two country groups appears to have widened over the period of financial globalization. Moreover, the pattern of consumption risk sharing is related to the degree of financial openness: countries with more open capital accounts, and larger stocks of foreign assets and liabilities exhibit larger degrees of risk sharing. Yet, larger countries in terms of gross domestic product show lower degrees of consumption risk sharing.

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.

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.