Despite a vast empirical literature that assesses the impact of financial integration on the economy, evidence of substantial welfare gains from consumption risk sharing remains elusive. While maintaining the usual cross-country perspective of the literature, this paper explicitly accounts for household heterogeneity and thus relaxes three restrictive assumptions that have featured prominently in the past. By making use of international household-level data and a subjective measure of financial well-being, the analysis takes into account idiosyncratic shocks to the household, allows for a household-specific evaluation of labor income risk and facilitates explicit tests of the underlying insurance channels. Using two balanced panels of more than 17,000 and 31,000 households from up to 22 European countries over the periods 1994-2000 and 2004-2008, respectively, I first document a negative welfare effect arising from labor income risk. I then show that financial integration significantly mitigates this effect for the average household in the sample. Finally, I examine the underlying insurance channels and find that, during the 1990s, the benefits of financial integration occurred primarily in the form of better access to credit for households with only weak ties to the financial system. During the 2000s, however, the largest gains from financial integration emerged on the asset side and benefited in particular households that had already invested in financial markets.
International topics International financial markets Labour markets Recent economic and financial developments