Financial Liberalization and Consumption Volatility in Developing Countries

By Andrei A. Levchenko. International Monetary Fund Staff Papers, 2005

120 citations recorded by the source corpus.

One of the chief benefits of financial liberalization proposed by theoretical literature is that it should allow countries to better smooth consumption through international risk sharing. Recent empirical evidence does not support this prediction. In developing countries, financial liberalization seems to be associated with an increase in consumption volatility. This paper seeks to rationalize the evidence by linking it to two important features of developing countries. First, domestic financial markets are underdeveloped. We model this by adopting the Kocherlakota (1996) framework of risk sharing subject to limited commitment. Second, access to international markets is not available to all members of society. We show that when risks are idiosyncratic, that is, insurable within the domestic economy, opening up to international markets reduces the amount of risk sharing attained at home and raises the volatility of consumption. When risk is aggregate to the economy, the underdeveloped financial system prevents the pooling of aggregate risk across agents for the purposes of insurance in the international markets. Thus, while the volatility of consumption coming from aggregate risk decreases with financial liberalization, it does so by much less than would be predicted by a representative agent model.

Subfields: Economics and Econometrics, Finance

View Paper: https://www.semanticscholar.org/paper/793bbc2a195eb598acf6f4bd303c616a9c86f022

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Citations in the corpus

Financial Globalization and Economic Policies (2009, unknown): “…markets) is higher for countries with higher private credit/stock market turnover and stock market capitalization, respectively.32 31 For instance, Levchenko (2005) and Leblebicioglu (2006) consider dynamic general equilibrium models where only some agents have access to international financial…”
How Does Financial Globalization Affect Risk Sharing? Patterns and Channels (2007, unknown): “For instance, Levchenko (2005) and Leblebicioglu (2006) construct dynamic general equilibrium models where only some agents have access to international financial markets.”
Foreign Direct Investment and Economic Growth in the Short Run and Long Run: Empirical Evidence from Developing Countries (2019, methodology): “Data are collected from the World Development Indicators (WDI) published by the World Bank (2019).”
The impact of digital finance on household consumption: Evidence from China (2020, background): “…to the theoretical analysis, it was believed the expansion of consumption credit services could relieve residents from liquidity constraints, thus facilitating consumption (Cochrane, 1991) and the development of the financial market could promote consumption growth (Bayoumi, 1993; Levchenko, 2005).”
Reaping the Benefits of Financial Globalization (2008, background): “It may also result from a dependence of risk-sharing benefits on whether countries have in place certain preconditions—related for example to trade openness or domestic financial sector development (Kose, Prasad and Terrones, 2007; Levchenko, 2005).”
The rise of digital finance: Financial inclusion or debt trap? (2021, background): “Levchenko (2005) explains that in developing countries, consumption volatility may increase with financial liberalization. aking easier access to the credit market as a liquidity shock, we set our second hypothesis as follows; H2: Easier access to credit markets is related to a higher level of…”