Financial Integration And Consumption Smoothing

The authors present a new empirical strategy for testing if financial integration improves risk sharing opportunities and consumption smoothing. The test is based on a decomposition of the variance of consumption growth into a component that depends on the variance of permanent income shocks and one that depends on the variance of transitory shocks. They then test if the process of financial market integration and liberalization brought about by the introduction of the euro has made consumption less sensitive to income shocks in Italy. The paper makes a significant contribution also from a methodological point of view. They use panel data on income to identify non-parametrically a time series of the variances of the income shocks.