International Consumption Risk is Shared after All: an Asset Return View

71 Pages Posted: 25 Feb 2012 Last revised: 20 Mar 2012

See all articles by Karen K. Lewis

Karen K. Lewis

University of Pennsylvania - Finance Department; National Bureau of Economic Research (NBER)

Edith X. Liu

Board of Governors of the Federal Reserve System

Date Written: February 2012

Abstract

International consumption risk sharing studies have largely ignored their models' counterfactual implications for asset returns although these returns incorporate direct market measures of risk. In this paper, we modify a canonical risk-sharing model to generate more plausible asset return behavior and then consider the effects on welfare gains. Matching the mean and variance of equity returns and the risk-free rate requires persistent consumption risk, leading to three main findings: (1) risk-sharing gains decrease as the ability to diversify persistent consumption risk decreases; (2) the international correlation of equity returns is high relative to the correlation of consumption and dividends, implying low diversification potential for persistent consumption risk; and (3) increasing persistent consumption risk reduces the gains. Taken together, our findings suggest that asset returns imply more international risk sharing than previously thought.

Suggested Citation

Lewis, Karen Kay and Liu, Edith X., International Consumption Risk is Shared after All: an Asset Return View (February 2012). NBER Working Paper No. w17872, Available at SSRN: https://ssrn.com/abstract=2010965

Karen Kay Lewis (Contact Author)

University of Pennsylvania - Finance Department ( email )

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Edith X. Liu

Board of Governors of the Federal Reserve System ( email )

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HOME PAGE: http://https://www.federalreserve.gov/econresdata/edith-x-liu.htm

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