The Feasible Gains from International Risk Sharing
28 Pages Posted: 18 Jun 2001
Date Written: 2003
The literature has documented an international risk sharing puzzle: there seem to be substantial unexploited gains from international risk sharing. In this paper we analyze the relative contributions of the intertemporal and the cross-sectional smoothing channel to this puzzle. We find that the unexploited gains from intertemporal smoothing are large (2.8% for the representative G7 country during 1956-1992). By contrast, the gains from cross-sectional smoothing, once complete intertemporal smoothing has been achieved, seem to be small. Furthermore, we find that intertemporal gains are easier to achieve than cross-sectional gains: their implementation causes less incentive problems (moral hazard and default) and they can to a large extent be realized through existing financial assets. We conclude that instead of a general international risk sharing puzzle, we face an intertemporal smoothing puzzle.
Keywords: international risk sharing, incentive constraints, welfare gains
JEL Classification: F40, G15
Suggested Citation: Suggested Citation