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

51 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 demand is imperfectly correlated across countries. This paper shows 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. With exporters making market- specific choices under uncertainty, countries whose shocks are riskier, in the sense that they contribute more to aggregate volatility, are less attractive destinations for both investment and exports. A gravity-type regression lends support to the hypothesis that, conditional on trade costs and market size, exporters sell smaller quantities in riskier destinations. I develop a general equilibrium trade model, with risk-averse investors and complete asset markets, which rationalizes this novel fact. A counterfactual experiment shows that risk-based comparative advantage accounts for 4.6% of global trade. Country-level exports would grow by -13% to +10% if all diversification opportunities were eliminated, entailing welfare losses in the range of .4% to 16%.

Keywords: Global Risk Sharing, international trade, structural gravity

JEL Classification: F15, F36, F44, G11

Suggested Citation

Heiland, Inga, Global Risk Sharing Through Trade in Goods and Assets: Theory and Evidence (December 2019). CEPR Discussion Paper No. DP14230. 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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