International Risk Sharing Across the Twentieth Century

1. International Risk Sharing Across the Twentieth Century David S. Jacks Simon Fraser University and NBER Christopher M. Meissner University of California, Davis & NBER

2. How much risk sharing has there been over the last 100 years? • We use an asset pricing model to find out (cf. Brandt, Cochrane and Santa Clara, 2006) • We find that risk sharing has been high despite other research to the contrary.

3. International Risk Sharing to Date • Key idea is that consumers can rely on foreign asset markets to cover risks. • If so then consumption should be highly correlated across countries and exchange rates should not move (much).

4. International Risk Sharing to Date • But many studies (too many to mention) document that consumption correlations are very low. • Co-movement of C with real exchange rate is opposite to what theory would expect.

5. Risk sharing in the long run • Consumption data is too poor prior to WWII to make much sense. • Historical evidence of U-shaped integration. • Price-based evidence is a prospect

6. The BCSC Measure • BCSC use an asset pricing model to measure how much exchange rate movement impedes international risk sharing. • The key is to note that real exchange rates move positively with the difference in the growth of marginal utility.

7. The Risk Sharing Measure • Which relies on the idea that:

8. The Risk Sharing Measure • M asks how much of the total volatility of the growth of marginal utility (h,a) is accounted for by exchange rate volatility?

9. Data • We calculate “excess” stock market returns (US and foreign) and exchange rate volatility. Use ex post real returns. • Australia (1920-1999), Belgium (1950-1999), Canada (1935-1999), Finland (1960-1999), France (1900-1989), Germany (1925-1999), Italy (1925-1999), Japan (1920-1999), Netherlands (1950-1999), South Africa (1960-1999), Spain (1940-1999), Sweden (1960-1999), and the UK (1900-1999). • We calculate the index with overlapping ten year periods 1900-1909, 1905-1914, 1910-1919,…, 1990-1999,

11. Results • For US and the G7 countries in our sample: • the measure never dips below 0.80 with one exception (Italy in 1985-1995). • The average value for the six series is 0.97 • 92% of observations being above 0.90 in value. • Interestingly, there are times when risk sharing uniformly declines. These periods are 1930-1939, 1965-1975, and 1980-1995. • M forUS and UK is at its maximum 1900-1915

13. Robustness • A consumption based measure can be calculated directly. It is much lower…0.36. This may measure overall risk sharing. M only captures risk shared via incomplete asset markets. • What additional (uncovered risks) would be necessary to lower overall risk sharing? High volatility (50%) and a negative correlation of -0.4 would get us 0.36. • Also, exchange rate volatility would have to be very high (>50%) to drop risk sharing downwards. • A “true” equity premium of 1% could lower the measure to 0.3. • Cross-border holdings are low but this is not necessarily an explanation. Income shocks may be correlated or risk can be shared by other means.

14. Further Thoughts • This is a price based measure. Similar structures can give rise to seemingly high integration. • Still, this means that there is little risk to be shared. Risk sharing is not that bad.

15. Further Thoughts & Conclusions • The BCSC measure of risk sharing displays high risk sharing over the twentieth century with some (important) dips. • Previous research on capital market integration pre-1950 looks at finance in the development process. • More work could be done to think about the risk sharing benefits of such integration.