International financial integration and risk sharing among countries: A production-based approach

This paper develops a production-based model for analyzing a role of asset trade in pooling risks among countries and provides new evidence for the international consumption-output puzzle and risk sharing among countries. Efficient risk sharing rules among countries are the same as the conditions for full financial integration. Input prices and interest rates as well as technology shocks are found to be the driving variables for cross-country output co-movements. The international correlation puzzle reflects an inability to account for production risk sharing among countries in previous studies. The degree of international risk sharing is substantial relative to earlier estimates, which is largely realized from pooling production risks rather than consumption risks among countries.