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We derive a precautionary demand for international reserves in the presence of sovereign risk and show that political-economy considerations modify the optimal level of reserve holdings. A greater chance of opportunistic behavior by future policy makers and political corruption reduce the demand for international reserves and increase external borrowing. We provide evidence to support these findings. Consequently, the debt-to-reserves ratio may be less useful as a vulnerability indicator. A version of the Lucas Critique suggests that if a high debt-to-reserves ratio is a symptom of opportunistic behavior, a policy recommendation to increase international reserve holdings may be welfare-reducing.

Though theory suggests financial globalization should improve international risk sharing, empirical support has been limited. We develop a simple welfare-based measure that captures how far countries are from the ideal of perfect risk sharing. We then take it to data and find international risk sharing has, indeed, improved during globalization. Improved risk sharing comes mostly from the convergence in rates of consumption growth among countries rather than from synchronization of consumption at the business cycle frequency. Our finding explains why many existing measures fail to detect impro

Abstract.  Though financial globalization should improve international risk sharing, empirical support is lacking. We develop a simple welfare‐based measure that captures how far countries are from the ideal of perfect risk sharing. Applying it to data, we find some evidence that international risk sharing has improved during globalization. Improved risk sharing comes mostly from the convergence in rates of consumption growth among countries rather than from synchronization of consumption at the business cycle frequency.