Information Globalization, Risk Sharing and International Trade

Abstract

Information frictions are often invoked to explain low levels of international trade beyond those that measured trade frictions (taris, transportation costs, etc.) can explain. But to explain why international trade is lower then domestic trade, home rms have to know something that foreigners do not. Without information asymmetry, domestic trade and foreign trade would be inhibited equally. This paper incorporates a simple information asymmetry in a standard, two-country Armington trade model and studies its eect on international risk sharing and trade ows. We nd that ameliorating information asymmetry { information globalization { reduces trade and international risk sharing. In other words, asymmetric information frictions behave in the opposite manner as a standard trade cost. Many researchers have explored the possibility that information frictions account for the low volumes of cross-border trade. Portes and Rey (2005) show that the volume of phone calls between two countries predicts how much they trade. Gould (1994) and Rauch and Trindade (2002) argue that immigrants trade more with their home countries. The argument that information frictions create uncertainty about foreign economies, and that this uncertainty deters risk-averse potential exporters is compelling. In many settings, the eect of an increase in uncertainty is to reduce the certainty-equivalent expected return, which acts like