Dynamic risksharing in the United States and Europe

We use a panel VAR model to improve upon the existing methodologies to analyze interregional risksharing and consumption smoothing channels. First, we endogenize the output process within a more general multi-equation framework, capturing the dynamic feedback between output and various smoothing channels. Second, in line with dynamic general equilibrium open economy models of risksharing, we exploit impulse response functions to trace the role of each smoothing channel over time, in the presence of different structural shocks (temporary vs. permanent and output vs. smoothing channels). In the application to the US and OECD countries, we find different dynamic properties of different smoothing channels. We compare our results with the predictions of standard risksharing and consumption theories, and tackle some of the puzzles in the literature, such as the “international risksharing puzzle” and the “consumption-output correlation puzzle.” We are also able to address such policy issues as whether fiscal stabilizers have been substitutes or complements for financial market diversification activities and whether further financial market integration is likely to provide countries with more shock-absorption tools. A key result is the strong substitutability between capital and credit smoothing in the US, and between fiscal and credit smoothing in the OECD.