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

► 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.

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).

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.

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

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.

The Risk Sharing Measure ► Which relies on the idea that:

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?

Data ► We calculate “excess” stock market returns (US and foreign) and exchange rate volatility. Use ex post real returns. ► Australia ( ), Belgium ( ), Canada ( ), Finland ( ), France ( ), Germany ( ), Italy ( ), Japan ( ), Netherlands ( ), South Africa ( ), Spain ( ), Sweden ( ), and the UK ( ). ► We calculate the index with overlapping ten year periods , , ,…, ,

Results ► For US and the G7 countries in our sample:  the measure never dips below 0.80 with one exception (Italy in ).  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 , , and  M for US and UK is at its maximum

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 ► 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.

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.

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.