The Home Bias, Capital Income Flows and Improved Long-Term Consumption Risk Sharing between Industrialized Countries

Is financial globalization associated with improved international consumption risk sharing? We argue that, theoretically, the impact of financial globalization should show up first and most robustly in the lower frequencies of the data, and we show that this is the case empirically: by the end of our sample period (1960-2007), up to 40% of long-term idiosyncratic consumption risk is shared between industrialized countries - as compared to less than 10% before 1990. This dramatic increase is associated with a huge increase in international capital income flows: while capital income flows remain relatively limited as a channel of risk sharing at business-cycle horizons, their contribution to international risk sharing at longer horizons has increased substantially. Much of this increase can be attributed to the growth in international asset positions over the recent globalization period.