Uncertainty and International Trade in the Presence of Stock Markets

Abstract

Like many other branches of economic theory, international trade theory has experienced growing interest in uncertainty problems during the last few years. Several sources of uncertainty were examined: uncertainty in preferences, which induces uncertainty in the terms of trade ([12]);1 uncertainty in the terms of trade without reference to more basic causes ([1], [3], [15], [16], [17]); and technological uncertainty ([4], [17]). In some cases, trading commitments were assumed to take place before the resolution of uncertainty ([3], [15]); in other cases, trading commitments were assumed to take place only after the resolution of uncertainty ([1], [3], [4], [12], [16], [17]). However, a common (and crucial) feature of all the models used in the above works is that they did not contain international risk-sharing arrangements. The main conclusion of this body of literature was that the basic theorems of international trade theory (Factor Price Equalization, Stolper-Samuelson, Rybczynski and Specialization According to Comparative Advantage) do not carry over to uncertain environments. In this paper, we develop a different model of international trade under conditions of uncertainty. Its main novelty is that it contains stock markets. The model results from an integration of the theory of international trade with recent developments in the theory of financial markets. (For the latter, see [5], [6], [8], [9], [13].) We show that many of the models used by earlier writers can be interpreted as special cases of our model, if we do not allow international trade in securities. Using this interpretation, we explain why the basic theorems of international trade do not carry over to uncertain environments in the absence of international risk-sharing arrangements (Section 4). Then, we show that the basic theorems of international trade do carry over to uncertain environments if international trade in securities is admitted into the model (Section 5). However, it should be emphasized that the stock market model does not enable perfect risk sharing as do the Arrow-Debreu model of contingent commodities and the model of Arrow-type securities; our model contains incomplete markets rather than complete markets. An economy with a stock market is described in Section 2. In Section 3, we apply the framework of Section 2 to the Ricardian and Heckscher-Ohlin models, assuming that no international trade in shares is allowed to take place. In Section 4, we discuss the implications of our Section 2 models. In Section 5, we introduce international trade in shares and future markets, and discuss their implications. Finally, in Section 6, we discuss limitations and possible extensions of our work.