Risk-sharing and EMU

Abstract:

What are the prospects that risk-sharing in EMU will ever attain the levels in the US? So far as risk-sharing in the US depends on interregional transfers through the budget of the federal government, those prospects are poor. So far as the risk-sharing in the US takes place though market channels, they are much better. This article addresses the theory and evidence on the subject. The evidence would indicate that EMU still lags far behind the US as regards the pooling of risks through portfolio diversification. But there already seems to be little to distinguish the euro area from the US in the ability to borrow to smooth shocks. Thus, some extra risk-sharing should already be taking place in the euro area through this channel. But how much? Further, there is also evidence that the progress of European economic and monetary integration over the last decade has increased the symmetry of business cycles. But this evidence is difficult to interpret. It could even be a sign of remaining capital-market imperfections. With respect to the theoretical aspects, one of the issues in the article is the adequacy of the general framework that Asdrubali, Sørensen and Yosha have proposed for dealing with all of these questions.

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