Global Risk Sharing Through Trade in Goods and Assets: Theory and Evidence

50 Pages Posted: 14 Jan 2020

See all articles by Inga Heiland

Inga Heiland

CESifo (Center for Economic Studies and Ifo Institute) - Ifo Institute

Date Written: December 2019

Abstract

Exporting not only provides firms with profit opportunities, but can also provide for risk diversification if is demand is stochastic and shocks are imperfectly correlated across countries. I develop a general equilibrium trade model, with risk-averse investors and complete asset markets, to show that the correlation pattern of demand shocks across countries constitutes a hitherto unexplored source of comparative advantage that shapes trade flows and persists even if financial markets are complete. The model yields a risk-augmented gravity equation, predicting that, conditional on trade costs and market size, exporters sell smaller quantities to countries whose shocks contribute more to aggregate volatility. I estimate the risk-augmented gravity equation using thirty years of data on trade flows and find support for the model's prediction. A counterfactual experiment shows that demand-risk-based comparative advantage accounts for 4.6% of global trade.

JEL Classification: F15, F36, F44, G11

Suggested Citation

Heiland, Inga, Global Risk Sharing Through Trade in Goods and Assets: Theory and Evidence (December 2019). Available at SSRN: https://ssrn.com/abstract=3518568

Inga Heiland (Contact Author)

CESifo (Center for Economic Studies and Ifo Institute) - Ifo Institute ( email )

Poschinger Str. 5
Munich, 01069
Germany

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