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To what extend can financial globalization promote risk sharing in emerging market

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There is no evidence showing that financial globalisation increases the ability to share risk in emerging markets

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To what extend does financial globalisation promote risk sharing in emerging market

For many years, financial globalisation has been promoted as a vehicle to increasing global linkages created through cross-border financial flows. In theory, one of the advantages of financial globalization is that a country can diversify the risk more efficiently with well-established domestic financial markets and increasing global linkages. However, based on the data analysis for recent period of globalisation and empirical literature studies, this is not the truth. In term of risk sharing, only industrial countries have attained some benefits from financial globalisation, while the emerging markets have little change in their ability to share risk, at least in a statistically significant way. (Kose, Prasad and Terrones,2007). There are many reasons can explain why risk sharing does not apply to the emerging markets, but for the purpose of this essay, only two possibilities will be discussed. One is the different types of capital flows in emerging markets, and the other one is structural features in emerging market.

Different types of capital flows may be more or less conducive to risk sharing, while emerging markets may simply not have the "right" type of capital flows. To prove this assumption, Kose, Prasad and Terrones (2007) used a panel regression, focusing on stock measures of foreign direct investment (FDI), equity (portfolio equity), debt (portfolio debt), and (FDI + equity). The result shows that FDI and equity are significant for all industrial countries, while neither of them seem to help in sharing risk in emerging markets. Furthermore, debt stocks appear to have no role in promoting risk sharing in industrial countries but it reduces the level of risk sharing significantly in emerging markets. A similar result also reported in the article written by Rodrik and Andres (2000). Combine these results with the fact that in emerging markets, portfolio debt dominated the external liability positions, then it can explain why emerging markets have not attained the risk-sharing benefits of financial globalization.

It is also possible that the weakness in structural factors or domestic policy environment may cause the inability of emerging markets to gain improved risk sharing through financial globalisation. The traditional measurement way used in the literature is a de jure indicator of capital account openness, based on compilations of the restrictions a country imposes on cross border capital account transactions. However, this is argued by Kose et el. (2009) that de jure measures cannot capture the enforcement and effectiveness of capital controls, so it may not explain the true extent of financial integration. Thus, by using the de facto measurement and adding binary variables to represent the variation in country characteristics, Kose, Prasad and Terrones (2009) examined the role of three factors in the regressions —trade openness (the sum of exports and imports to GDP), the level of financial sector development (crudely measured as the ratio of domestic credit to GDP), and a measure of institutional quality. The result indicates that higher trade openness is positive correlated with better risk sharing among emerging markets, while better institutional quality is negative correlated with risk sharing. This latter result is a little puzzling and this puzzle might be related to a threshold effect associated with the degree of financial integration which is mentioned by Prasad et el. (2003). Since industrial countries do seem to enjoy the risk sharing benefits of financial globalisation but the results show that none of these country characteristics matter for the degree of risk sharing attained by emerging market economies. This suggests that, in order to attain these benefits, emerging markets need to become more integrated into global financial markets.

All in all, in this essay, we discussed two possibilities - different types of capital flows and structural features - that may prevent emerging markets from obtaining the profits in the financial globalisation. Putting two possible explanations for weak risk sharing together, it can simply get the conclusion here. Due to the fact that portfolio debt dominated the external liability positions in emerging markets and the threshold effect, although theory predicts that financial integration should allow all countries to improve the risk sharing by diversifying their idiosyncratic income risk, emerging market economies cannot enjoy the risk sharing benefits of financial globalisation.

Reference

Kose, M., Eswar S., Kenneth, R., & Shang, J, (2006) Financial Globalisation: A Reappraisal. Washington: International Monetary Fund

Kose, M., Prasad, E. & Terrones, M. (2007). How Does Financial Globalisation Affect

Risk Sharing? Patterns and Channels. IMF working paper, pp. 1-47

Kose, M., Prasad, E. & Terrones, M. (2009). Does financial globalisation promote risk sharing? Journal of Development Economics, 89, pp. 258-270.

Prasad, E., Rogoff, K., Wei, S. & Kose, M. (2003) Effects of Financial Globalisation on Developing Countries: Some Empirical Evidence. Economic and Political Weekly, 38, pp. 4319-4330.

Rodrik, D. and Andres V. (2000) Short-Term Capital Flows. Annual World Bank

Conference on Development Economics 1999. Washington: World Bank, pp. 59–90.

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To what extent does financial globalisation promote risk sharing in emerging markets? 

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To what extent does financial globalisation promote risk sharing in emerging markets? 

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For many years, financial globalisation has been promoted as a vehicle to strength global links through cross-border financial flows. In theory, it is one of the advantages of financial globalisation, a country can perfect the domestic financial market and increasing global connections, spread risk more effectively. However, based on the data analysis for recent period of globalisation and empirical literature studies, this is not the truth. In term of risk sharing, only industrialised countries have benefited from financial globalisation, while emerging markets' risk-sharing capacity has barely changed, at least in a statistically significant way. (Kose, Prasad and Terrones,2007). There are many reasons can explain why risk sharing does not apply to the emerging markets, but for the purpose of this essay, only two possibilities will be discussed. One is the different types of capital flows in emerging markets, and the other one is structural features in emerging market.

It is generally agreed that different capital inflows can help to spread risk more or less. While emerging markets which already have a relatively high level of financial integration seem can just gain few benefits in this part. So economists conduct in-depth research on the capital flows structure of emerging markets and find that certain types of financial assets may be more conducive to achieving the benefits of risk sharing. To prove this assumption, Kose, Prasad and Terrones (2007) used a panel regression with 4 parameters, which are the stock index of FDI (foreign direct investment), net inflows from equity securities (portfolio equity), net inflows from debt (portfolio debt), and the crossover value of FDI and portfolio equity. The result shows that FDI and portfolio equity are significant for all industrial countries, while neither of them seem to approve the risk sharing in emerging markets. Furthermore, portfolio debt did not appear to have any effect on promoting risk sharing in industrialized countries but it reduces the level of risk sharing significantly in emerging markets. A similar result also reported in the article written by Rodrik and Andres (2000), who notes that specific types of financial assets have more impact on the ability of risk sharing. Combine these results with the fact that in emerging markets, portfolio debt dominated the external liability positions, then this may explain why emerging markets have not benefited from the risk-sharing benefits of financial globalisation..

Except for the impact of different types of capital flows, it is also possible that structural factors or a weak domestic policy environment could prevent emerging markets from obtaining better risk sharing through financial globalisation. The traditional method of measurement used in literature is a de jure indicator of capital account openness, which is commonly quantified by stocks or flows of international capital relative to GDP. While, Kose et el. (2009) argued that one limitation of this approach is that it fails to capture the implementation and effectiveness of capital controls, so It may not be able to explain the truth of financial integration. Thus, by changing the method to de facto measurement and adding country characteristics as binary variables, Kose, Prasad and Terrones (2009) studied the role of three factors in the regressions —trade liberalization (the total share of imports and exports in GDP), financial sector development (roughly measured as a share of domestic credit in GDP), and measures of institutional quality. The results show that the higher the degree of trade openness, the higher the risk sharing level of emerging markets, while the better the quality of institutions, the lower the risk sharing level. The latter result is a bit of puzzling that may have to do with the threshold effect that Prasad et el. (2003) point to in relation to the degree of financial integration. Since industrial countries indeed seem to enjoy the risk sharing benefits of financial globalisation the findings suggest that these national characteristics have no impact on the degree of risk-sharing achieved by emerging market economies. That means emerging markets need to become more integrated into global financial markets in order to reap these benefits.

To conclude, this essay discussed two possibilities - different types of capital flows and structural features - that may prevent emerging markets from obtaining the profits in the financial globalisation. Due to the dominant external liability for the debts of the combination of position in the emerging markets and the threshold effect, although the theory predicts that financial integration in all countries should be allowed to improve its special revenue diversification of risk sharing risk, emerging market economies cannot enjoy the benefits of financial globalisation risk sharing.

Reference

Kose, M., Eswar S., Kenneth, R., & Shang, J, (2006) Financial Globalisation: A Reappraisal. Washington: International Monetary Fund

Kose, M., Prasad, E. & Terrones, M. (2007). How Does Financial Globalisation Affect

Risk Sharing? Patterns and Channels. IMF working paper, pp. 1-47

Kose, M., Prasad, E. & Terrones, M. (2009). Does financial globalisation promote risk sharing? Journal of Development Economics, 89, pp. 258-270.

Prasad, E., Rogoff, K., Wei, S. & Kose, M. (2003) Effects of Financial Globalisation on Developing Countries: Some Empirical Evidence. Economic and Political Weekly, 38, pp. 4319-4330.

Rodrik, D. and Andres V. (2000) Short-Term Capital Flows. Annual World Bank

Conference on Development Economics 1999. Washington: World Bank, pp. 59–90.