International Risk Sharing: The Evidence Presenters Gaurav Saroliya Neil McMurdo Lucy Broomfield

Investment Risk Sharing Feldstein&Horioka Saving-Investment Puzzle For an economy participating in world capital markets CA t = B t+1 – B t = Y t + r t B t – C t – G t – I t = S t – I t Feldstein and Horioka (1980) show for 16 OECD countries ( ) I/Y = S/Y, R 2 = 0.91 Obstfeld and Rogoff (1995) showed for 22 OECD countries ( ) I/Y = S/Y, R 2 = 0.69 Obstfeld (1986, 1995) shows that capital is quite mobile within the developed world; closely similar interest rates on comparable assets in different countries.

Scepticism about the F-H Interpretation Common factors influence saving and investment: Current account targeting through fiscal and monetary measures (though evidence is anecdotal) Developed countries operate at near steady state levels of external debt or assets leading to little long term variation in savings and investment Demographic and productivity changes having similar effects on long-term saving and investment. Taylor (1994) runs the F-H equation controlling for (1)domestic relative prices, (2) age structure of the population, and (3) interaction of age structure with output growth. Finds for several countries no association between saving and investment

Segmented International Goods Markets Home Bias in Trade McCallum (1995) shows that, in 1988, trade among individual Canadian provinces was 20 times greater than trade between individual Canadian states and individual US states Tempered estimates: Home bias factor of 12 (Helliwell, 1998) over , and, using indirect methods, 2.5 (Wei, 1998) and approx 7 (Evans, 1998) Domestic markets more integrated than international markets

International Portfolio Diversification Home Bias in Equity Holding For a financially open economy, the dynamic general equilibrium asset pricing model (C-CAPM) predicts assets to be widely held across international markets Evidence: French and Poterba (1991) show that 91% of US and 98% of Japanese equity holding was domestic Tesar and Werner (1998) show that home bias is less strong for smaller countries and has tended to decline over time

Low Consumption Risk Sharing Complete Markets Arrow-Debreu framework predicts perfect correlation in the consumption of trading countries Backus, Kehoe and Kydland (1992) highlight the fact that international output growth are more highly correlated than consumption growth rates. Consumption risk pooling higher across regions within the same country than across national boundaries

References Evans, C (1999), Do National Borders Matter? Doctoral Dissertation, Harvard University French, K and Poterba, J (1991), “Investor Diversification and International Capital Markets,” American Economic Review, 81 (May) Helliwell, J (1998), How much do National Borders Matter? Washington DC: Brookings Institution Lewis, K (1999), “Trying to Explain Home Bias in Equities and Consumption,” Journal of Economic Literature, 37(2), June McCallum, J (1996), “National Borders Matter: Canada-US Regional Trade Patterns,” American Economic Review, 85 (June) Obstfeld, M (1986), “Capital Mobility in the World Economy: Theory and Measurement,” Carnegie-Rochester Conference Series on Public Policy, 24 (Spring) Obstfeld, M (1995), “International Capital Mobility in the 1990s.” In Understanding Interdependence: The Macroeconomics of the Open Economy, Peter B Kenen (ed), Princeton, NJ: Princeton University Press Taylor, A (1994), “Domestic Savings and International Capital Flows Reconsidered, NBER WP4892, October Wei, S (1998), How Reluctant are Nations in Global Integration? Mimeo. Harvard University (January)