Common Correlated Effects and International Risk Sharing

Existing studies of risk pooling among groups of countries are predicated upon thehighly restrictive assumption that all countries have symmetric responses to aggregateshocks. We show that the conventional risk sharing test fails to isolate idiosyncratic uctuations within countries and produces spurious results. To avoid these problems,we propose an alternative form of the risk sharing test that is robust to heterogeneouscountry characteristics. In our empirical example, we provide estimates using the pro-posed approach for various groupings of 158 countries.