veloped countries are also more likely to benefit from international risk sharing. Moreover,
deeper financial markets (as indicated by a higher stock market capitalisation) also leads
to more pro-cyclicality of the beta coefficients.
Our interpretation of this result is that a higher stock market capitalisation implies a
better coverage of the economy. Hence, business cycle fluctuations are more visible in the
stock market performance. Specifically for the rate of capital gains in domestic currency
a one percentage point increase in the ratio leads to 0.34 unit increase in βi. Hence, this
result strengthens the proposition that also increasing equity shares in foreign liabilities
facilitate economic smoothing.
For the bond market coefficient none of the explanatory variables is found to be sig-
nificant in domestic currency. In US dollar terms we find a negative coefficient on bond
market capitalisation which would imply that the risk-sharing via short positions would
be increasing with more financial deepening in bonds.12
By and large, we find evidence for more risk sharing potential, the higher a country is
developed - that is both in terms of output per capita as well as having more developed
financial markets.
5 Conclusion
In this paper the ability of countries to smooth their economic performance across different
states of the world is examined. When looking at capital gains on domestic stock markets,
economic smoothing is especially feasible when the investment horizon amounts to five
years. Country analysis reveals strong pro-cyclicality for Australia, the Netherlands and
Sweden in terms of capital gains on domestic stock markets.
This suggests that economic smoothing through the capital gains channel is working
for certain countries. In addition, this could be achieved for further countries with an
increase in the level of GDP per capita and larger financial markets. Thus, we find that
in times of financial globalisation with higher equity shares in international portfolios,
economic smoothing and consequently enhanced international risk-sharing becomes more
and more feasible. In terms of “optimal” risk sharing one could recommend based on our
evidence to attract foreign investments into medium term equity investments and short
positions in bond markets.
The extended version of this paper comprises the equivalent analysis of international
12The βis for this estimation were generally rather insignificant. Hence this results has only limited
explanatory power.
10