An intensely debated issue in international economics concerns the extent to which investors exploit the benefits from international trade in financial assets. Such benefits have long been acknowledged in theory but, despite the continuing process of financial integration and global-ization, it is unclear whether they are fully exploited in actual practice.
This article reexamines some of the evidence concerning the degree to which international financial markets help countries diversify away country-specific risks to achieve a mutually preferable allocation of consumption. By looking at national consumption correlations across G-7 countries, the author investigates whether greater incentives to diversify risks internationally have been accompanied by an effective increase in consumption risk-sharing. He finds that the apparent lack of consumption risk-sharing found in prior studies continued to persist in the 1990s and that the puzzle of low international consumption correlations is probably worse than usually thought. The author then considers alternative explanations for the puzzle and proposals to achieve a better degree of international risk-sharing.