Financial integration and consumption risk sharing in East Asia

This paper estimates the degree of consumption risk sharing and analyzes the channels of consumption risk sharing among the 10 East Asian countries. Estimation results show that a bulk of cross-sectional variance of GDP, about 80 percent, is not smoothed within the region which suggests that the degree of consumption risk sharing is far from complete and very low in the region. Capital markets play a minimal role and credit markets provide a positive but limited role. These results imply that the market channels do not function well in smoothing idiosyncratic output shocks. To be consistent, we also found that the potential welfare gains from consumption risk sharing within East Asia are quite large. Compared to the OECD countries, the degree of risk sharing achieved is lower and the potential gains are larger in the East Asian countries, but the degree of risk sharing and the potential gains are similar in relatively more developed East Asian countries. (c) 2004 Elsevier B.V. All rights reserved.