Limited Participation, Nominal Volatility, and Risk Sharing: Monetary Union and Financial Development

Abstract

This paper explores the effects of nominal volatility and limited participation in asset markets on the risk sharing possibilities available to agents. When the set of financial assets is a decision of agents and is constrained by the resources available for investment, limited participation and nominal volatility can generate an inefficiently small number of financial assets. A monetary rule, such as a fixed exchange rate or monetary union, that reduces nominal volatility can foster the development of stock markets by increasing the number of equity securities. However, the welfare benefits and costs of a monetary union are asymmetrically distributed both across groups with different access to financial markets and across countries.