Capital mobility and international sharing of cyclical risk

This paper investigates whether the international globalization of financial markets allows for significant cross-country risk-sharing at the business cycle frequency. We find that cross-country risk-sharing is still limited and this is unlikely to be the result of financial frictions that limit state-contingent contracts. Part of the limited international risk sharing could be the consequence of frictions that de-facto reduce the short-term mobility of financial capital. But even with these frictions we find significant divergence between model predictions and the data.

► We investigate the degree to which risk is shared internationally using a two-country model.
► The simulation of the model for 21 countries shows that international risk-sharing is still limited.
► Incomplete markets do not explain the limited international risk-sharing at the business cycle frequency.
► Portfolio adjustment costs improve the performance of the model but only partially.