International Risk Sharing Research Articles

Evaluating the gains from international risksharing: A comment

Evaluating the gains from international risksharing: A comment

Evaluating the gains from international risksharing

Cross-country evidence on consumption, income, saving, and investment indicates that there remain opportunities for international risksharing. One explanation for the lack of global risksharing is that the gains are not sufficient to offset even small frictions. This paper evaluates the utility gains from risksharing under different assumptions about market structure, country size, technology, and preferences. I find that the gains from risksharing range from zero to two percent of lifetime consumption. When countries are able to “self-insure” by adjusting labor supply and investment, the gains from risksharing are insignificantly different from zero.

Welfare gains from international risksharing

This paper uses consumption data to compute yet unexploited welfare gains that can be achieved through risksharing among twenty OECD countries. There is both aggregate national consumption risk and nondiversifiable individual-specific risk. Countries engage in an optimal risksharing arrangement to pool risk associated with the aggregate consumption endowment streams. Welfare gains are associated with reduced consumption variability and with the international pricing of the consumption streams of individual countries. The paper considers the standard VNM time-additive preferences, as well as nonexpected utility and habit formation preferences. Large unexploited gains are found under all sets of preferences, leading to an ‘international risksharing puzzle’.

International Risk Sharing and Economic Growth

International risk sharing which diversifies away income risk will reduce saving, with constant relative risk aversion. If growth arises from the external effects of human capital accumulation then reducing saving will reduce growth. Welfare also may fall with risk sharing, because endogenous growth with external effects of capital accumulation typically implies a competitive equilibrium growth rate already less than the optimal growth rate. We demonstrate these results in a standard, representative-agent economy. Diversifying away rate-of-return risk also will reduce saving and growth rates if relative risk aversion exceeds one, but this diversification always increases welfare. This paper studies the effects of international risk sharing (portfolio diversification) in a economy in which growth rates of income are endogenous. Growth is based upon the spillover effects of human capital accumulation. As in Lucas (1988) and Romer (1986), there are positive, economy-wide spillovers of human capital intensity on individual labour productivity. In Section 2 we construct a multi-country growth model with an infinitely-lived representative agent in each country. Each country faces income risk but there is no aggregate uncertainty at the level. We focus on two market structures. In the first structure there are no markets which allow for international diversification of country-specific income risk. In the second structure there are complete international markets for risksharing. With no aggregate world uncertainty, this completeness allows full diversification of country-specific risk. The paper has two central results. First, growth rates in all countries are lower in the equilibrium with full diversification. Second, in this same structure welfare of each country may be lower than in an equilibrium without risk sharing. The reasoning is as follows. With external effects of capital accumulation the compet

International risk-sharing and non-traded goods

The high correlation between savings and investment, the low cross-country correlation between consumption growth rates and the home bias in investment portfolios have been interpreted as evidence that international financial markets are insufficient for complete risk-sharing. This paper demonstrates that these facts are consistent with complete financial markets when agents face stochastic fluctuations in the output of non-traded goods. Consumer preferences over traded and non-traded goods and over the intertemporal allocation of consumption may skew portfolios toward claims on domestic output. A dynamic version of the model calibrated to estimates of the parameters describing preferences and technology replicates the main features of savings, investment, consumption and output.