Financial reforms and low-income households' impact on international consumption risk sharing

Abstract

Complete financial markets allow countries to share their consumption risks internationally, thereby creating welfare gains through lower volatility of aggregate consumption. Using a panel of 116 countries between 1970 and 2019, I show that a higher share of low-income households reduces consumption risk sharing, especially so in less-developed countries. Moreover, I find that a broad range of financial market reforms and financial integration have a positive impact on international consumption risk sharing in poorer developing countries, while in emerging market countries, financial market development, financial reforms, and capital account openness has an impact. In advanced economies, financial (stock and bond) market development as well as financial integration improves international risk sharing. A lack of financial reforms, a lower degree of financial integration and a high share of low-income households thus contribute to the degree of risk sharing being lower in developing countries than in advanced economies.