Income insurance and the determinants of income insurance via foreign asset revenues and foreign liability payments

Balli, Faruk and Basher, Syed Abul and Ozer-Balli, Hatice (2011): Income insurance and the determinants of income insurance via foreign asset revenues and foreign liability payments.

Abstract

We document that the net factor income smoothing channel in OECD countries is primarily driven by net financial asset income, while the other two sub-components (net compensation of employees, net taxes on imports) turn out to be ineffective. Once factor income inflows are distinguished from outflows, empirical evidence suggests a non-significant effect of inflows in terms of income smoothing as opposed to a positive and significant role of factor income outflows (18 percent for the EMU and 16 percent for the EU). Factor income outflows also appear robust with respect to positive output shocks, while neither factor income inflows nor factor income outflows provide insurance against negative output shocks. In terms of the determinants of income smoothing, results indicate that an increase in foreign equity and debt liabilities positively affect the extent of smoothing via factor income outflows. Whereas, contrary to the current literature, an increase in foreign assets holding does not have a positive impact on smoothing via factor income inflows. The tendency of European investors' in allocating a sizeable portion of their assets within the Euro zone is shown to undermine income smoothing.

• Item Type: MPRA Paper
• Language: English
• Keywords: Factor income flows; Consumption smoothing; Income smoothing; International portfolio diversification.
• Subjects: F - International Economics > F3 - International Finance > F36 - Financial Aspects of Economic Integration

References

Afonso, A. and Furceri, D. (2007): Business cycle synchronization and insurance mechanisms in the EU. European Central Bank Working Paper No. 844.

Asdrubali, P., Sorensen, B.E. and Yosha, O. (1996): Channels of interstate risk sharing: United States 1963{90, Quarterly Journal of Economics 111, 1081-1110.

Atkeson, A. and Bayoumi, Y. (1993): Do private capital markets insure regional risk? Evidence from the United States and Europe, Open Economies Review 4, 303-324.

Backus, D.K., Kehoe, P.J. and Kydland, F.E. (1992): International real business cycles, Journal of Political Economy 100, 745-775.

Baele, L., Ferrando, A., Hordahl, P. Krylova, E. and Monnet, C. (2004): Measuring financial integration in the Euro area. European Central Bank Occasional Paper No. 14.

Balli, F. and Sorensen, B. (2007): Risk sharing among OECD and EU countries: The role of capital Gains, capital income, transfers, and saving. Unpublished manuscript, MPRA Paper No. 10223. Available online: http://ideas.repec.org/p/pra/mprapa/10223.html

Balli, F. (2009): Spillover effects on government bond yield spreads in Euro Zone. Does perfect integration exist among EMU members? Journal of Economics and Finance 33, 331-363.

Balli, F., Basher, S.A. and Jean Louis, R. (2009): Channels of risk-sharing among Canadian provinces: 1961{2006. Unpublished manuscript, Available online: http://ideas.repec.org/p/pra/mprapa/17299.html

Balli, F., Basher, S.A. and Ozer-Balli, H. (2010): From home bias to Euro bias: disentangling the effects of monetary Union on the European financial markets, Journal of Economics and Business 62, 347-366.

Baxter, M. and Crucini, M. (1993): Explaining saving-investment correlations, American Economic Review 83, 416-436.

Canova, F. and Ravn M. (1996): International consumption risk sharing, International Economic Review 37, 573-601.

Cochrane, J.H. (1991): A simple test of consumption insurance, Journal of Political Economy 99, 957-976.

De Haan, J., Inklaar, R. and Jong-a-Pin, R.M. (2008): Will business cycles in the euro area converge? A critical survey of empirical research, Journal of Economic Surveys 22, 234-273.

Demyanyk, J., Ostergaard, C. and Sorensen, B. (2008): Risk sharing and portfolio allocation in EMU. European Economy Economic Papers No. 334.

Foad, H.S. (2008): Equity Home Bias and the introduction of the Euro. Unpublished manuscript. Available online: http://www-rohan.sdsu.edu/~hfoad/EHB v6.pdf

French, K. and Poterba, J. (1991): Investor diversification and international equity markets, American Economic Review 81, 222-226.

Fuss, R., Schiereck, D. and Wilkes, A. (2010): Are European corporate bond markets integrated? A macro-finance term structure model approach. European Business School research paper No. 10-04. Available online: http://ssrn.com/abstract=1559027

Grubel, H.L. (1968): Internationally diversified portfolios: Welfare gains and capital flows, American Economic Review 58, 1299-1314.

Hodrick, R.J. and Prescott, E.C. (1997): Postwar U.S. business cycles: An empirical investigation, Journal of Money, Credit, and Banking 29, 1-16.

Kang, X. and Melas, D. (2010): A fresh look at the strategic equity allocation of European institutional investors. MSCI Barra Research. Available online: www.mscibarra.com

Karolyi, A. and Stulz, R. (2003): Are Financial Assets Priced Locally or Globally?, In George Constantinides, Milton Harris, and Rene M. Stulz, eds.: The Handbook of the Economics and Finance (North-Holland, NY).

Lane, P. and Milesi-Ferretti, G.M. (2007): The external wealth of nations mark II: Revised and extended estimates of foreign assets and liabilities, 1970-2004, Journal of International Economics 73, 223-250.

Lewis, K. (1995): Puzzles in international financial markets, In Gene Grossman and Kenneth Rogoff (eds) Handbook of International Economics, North Holland, Amsterdam.

Lewis, K. (1996): What explain the apparent lack of international consumption risk sharing?, Journal of Political Economy 104, 267-297.

Lewis, K. (1999): Trying to explain home bias in equities and consumption, Journal of Economic Literature 37, 571-608.

Mace, B.J. (1991): Full insurance in the presence of aggregate uncertainty, Journal of Political Economy 99, 928-956.

Melitz, J. and Zumer, F. (1999): Interregional and international risk sharing and lessons for EMU, Carnegie-Rochester Conference Series on Public Policy 51, 149-88.

Obstfeld, M. (1994): Are industrial-country consumption risks globally diversified? In L. Leiderman and A. Razin (eds), Capital Mobility: The Impact on Consumption, Investment, and Growth, Cambridge University Press, New York.

Obstfeld, M. and Rogoff, K. (1996): Foundations of international macroeconomics, MIT Press, Cambridge, USA.

Pagano, M. and von Thadden, E.-L. (2004): The European bond markets under EMU, Oxford Review of Economic Policy 20, 531-554.

Pierucci, E. and Ventura, L. (2010): Risk sharing: a long run issue?, Open Economies Review 21, 705-730.

Sorensen, B.E. and Yosha, O. (1998): International risk Sharing and European monetary unication, Journal of International Economics 45, 211-38.

Sorensen, B.E., Wu, Y.T., Yosha, O. and Zhu, Y. (2007): Home bias and international risk sharing: Twin puzzles separated at birth, Journal of International Money and Finance 26, 587-605.

Stockman, A.C. and Tesar, L. (1995): Tastes and technology in a two-country model of the business cycle: Explaining international co-movements, American Economic Review 85, 168-185.

Townsend, R. (1994): Risk and insurance in village India, Econometrica 62, 539-591.