International Risk Sharing is Better than You Think (or Exchange Rates are Much Too Smooth)
34 Pages Posted: 29 Jul 2001 Last revised: 9 Sep 2002
Date Written: July 2001
Exchange rates depreciate by the difference between the domestic and foreign marginal utility growths. Exchange rates vary a lot , as much as 10% per year. However, equity premia imply that marginal utility growths vary much more, by at least 50% per year. This means that marginal utility growths must be highly correlated across countries -- international risk sharing is better than you think. Conversely, if risks really are not shared internationally, exchange rates should vary more than they do -- exchange rates are much too smooth. We calculate an index of international risk sharing that formalizes this intuition in the context of both complete and incomplete capital markets. Our results suggest that risk sharing is indeed very high across several pairs of countries.
Note: This abstract & paper was mistakenly published in NBER Working Papers Series, Vol. 2, No. 41 without two of the authors' names included. This is the corrected version.
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