A Pedagogical Note on Risk Sharing Versus Instability in International Financial Integration: When Obstfeld Meets Stiglitz

Raouf Boucekkine (1, 2) , Benteng Zou (3)

1 AMSE - Aix-Marseille Sciences Economiques
2 IMéRA - Institute for Advanced Studies - Aix-Marseille University
3 CREA - Center for Research in Economic Analysis

The pure risk sharing mechanism implies that financial liberalization is growth enhancing for all countries as the world portfolio shifts from safe low-yield capital to riskier high-yield capital. This result is typically obtained under the assumption that the volatilities for risky assets prevailing under autarky are not altered after liberalization. We relax this assumption within a simple two-country model of intertemporal portfolio choices. By doing so, we put together the risk sharing effect and a well-defined instability effect. We identify the conditions under which liberalization may cause a drop in growth. These conditions combine the typical threshold conditions outlined in the literature, which concern the deep characteristics of the economies, and size conditions on the instability effect induced by liberalization.

Keywords: Economic growth; Financial liberalization; Risk sharing; Volatility; Emerging markets

Domains: Humanities and Social Sciences; Economics and Finance; Quantitative Finance [q-fin]

Raouf Boucekkine, Benteng Zou. A Pedagogical Note on Risk Sharing Versus Instability in International Financial Integration: When Obstfeld Meets Stiglitz. Open Economies Review, 2019, 30 (1), pp.179-190. ⟨10.1007/s11079-018-9514-z⟩. ⟨hal-01996294⟩