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Financial Integration and International Risk Sharing

Yan Bai () and Jing Zhang ()

No 371, 2006 Meeting Papers from Society for Economic Dynamics

Abstract: In the last two decades, financial integration has increased dramatically across the world. At the same time, the fraction of countries in default has more than doubled. Contrary to theory, however, there appears to have been no substantial improvement in the degree of international risk sharing. To account for this puzzle, we construct a general equilibrium model that features a continuum of countries and default choices on state-uncontingent bonds. We model increased financial integration as a decrease in the cost of borrowing. Our main finding is that as the cost of borrowing is lowered, financial integration and sovereign default increases substantially, but the degree of risk sharing as measured by cross section and panel regressions increases hardly at all. The explanation, we propose, is that international risk sharing is not sensitive to the increase in financial integration given the current magnitude of capital flows because countries can insure themselves through accumulation of domestic assets. To get better risk sharing, capital flows among countries need to be extremely large. In addition, although the ability to default on loans provides state contingency, it restricts international risk sharing in two ways: higher borrowing rates and future exclusion from international credit markets

Keywords: Finanical Integration; Risk Sharing; Globalization; Sovereign Debt (search for similar items in EconPapers)
JEL-codes: F34 F36 F41 (search for similar items in EconPapers)
Date: 2006
New Economics Papers: this item is included in nep-fmk
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Journal Article: Financial integration and international risk sharing (2012) Downloads
Working Paper: Financial Integration and International Risk Sharing (2009) Downloads
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