Together forever? Good and bad market volatility shocks and international consumption risk sharing: A tale of a sign

Abstract

Recent literature has shown that international financial integration facilitates cross-country consumption risk sharing. We extend this line of research and demonstrate that the decomposition of financial integration into good and bad plays an important role. We also propose new measures of countries’ capital market integration, based on good and bad volatility shocks, as well as country specific indices of consumption risk sharing. We document a decoupling of individual consumption growth from global risk sharing after episodes of negative cross-spillovers, and a recoupling after positive spillovers. Our results support current views in the literature that advocate for an asymmetric treatment of good and bad volatility shocks, in order to assess the macroeconomic dynamics that follow risk episodes. They also challenge previous views in the literature that present capital market integration (without differentiating between positive and negative shocks) as a prerequisite for higher international consumption risk sharing. Overall, they cast doubts on the actual scope for consumption risk sharing across global financial markets.