Taking Home Bias Seriously: Absolute and Relative Measures Explaining Consumption Risk-Sharing

Abstract

Recent empirical work has shown that ongoing international financial integration facilitates cross-country consumption risk-sharing. While these studies typically employ absolutemeasures to account for a country''s integration in international capital markets, we devise a relative measure that is motivated by the International Capital Asset Pricing Model (I-CAPM) literature. Our measure captures the composition of a country''s international portfolio relative to the world portfolio, which all countries should optimally hold according to the I-CAPM. Using panel-data regression for a group of OECD countries during the financial globalization period 1980-2007, we show that the geography of international portfolioshelps to explain the degree of consumption risk-sharing obtained.macroeconomics ;