Financial Globalization, Capital Account Liberalization and Risk Sharing

Conventional wisdom suggests that countries that are financially integrated should be better insured against macroeconomic risk. In this paper, I study whether international risk sharing has improved with greater financial integration during the period 1973-2003. Using panel data regressions, I demonstrate that risk sharing improves with greater financial integration for industrial countries, especially during the globalization period. However, developing countries do not show any discernible pattern in risk sharing. Emerging economies, which accounted for a huge share of capital flows in the recent past, show only a marginal change in risk sharing. Capital flows come in different types such as portfolio equity flows, debt flows, foreign direct investment among others and each affects risk sharing differently. I examine the unique role of different types of capital flows in risk sharing and find that risk sharing benefits are higher for industrial countries for each of these components. On the contrary, greater reliance on debt flows appears to have reversed the potential risk sharing gains for the emerging economies