Banks, Financial Markets and International Consumption Risk Sharing

In this paper we empirically explore how characteristics of the domestic financial system influence the international allocation of consumption risk using a sample of OECD countries. Our results show that the extent of risk sharing achieved does not depend on the overall development of the domestic financial system per se. Rather, it depends on how the financial system is organized. Specifically, we find that countries characterized by developed financial markets are less exposed to idiosyncratic risk, whereas the development of the banking sector contributes little to the international diversification of consumption risk. We also find that countries with market-based financial systems manage to share a significantly larger fraction of their country-specific risk than bank-based economies.