Working Paper: CEPR ID: DP14230
Authors: Inga Heiland
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.
Keywords: International Trade; Structural Gravity; Global Risk Sharing
JEL Codes: F15; F36; F44; G11
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| demand-risk-based comparative advantage (F14) | global trade (F19) |
| correlation of demand shocks across countries (F41) | trade patterns (F10) |
| demand risk (D81) | export quantities (F10) |
| covariances of demand shocks with stock market returns (G17) | trade volumes (F10) |