Working Paper: CEPR ID: DP14255
Authors: Isaac Baley; Laura Veldkamp; Michael Waugh
Abstract: Common wisdom holds that uncertainty impedes trade|yet we show that uncertainty can fuel more trade in a simple general equilibrium trade model with information frictions. In equilibrium, increases in uncertainty increase both the mean and variance in returns to exporting. This implies that trade can increase or decrease with uncertainty, depending on preferences. Under general conditions on preferences, we characterize the importance of these forces using a sufficient statistics approach. Higher uncertainty leads to increases in trade because agents receive improved terms of trade, particularly in states of nature in which consumption is most valuable. Trade creates value, in part, by offering a mechanism for risk sharing, and risk sharing is most effective when both parties are uninformed.
Keywords: trade; uncertainty
JEL Codes: No JEL codes provided
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Uncertainty (D89) | Trade (F19) |
| Uncertainty increases mean and variance of returns to exporting (D89) | Trade (F19) |
| Higher uncertainty (D89) | Improved terms of trade (F14) |
| Improved terms of trade (F14) | Trade (F19) |
| Uncertainty facilitates cross-country risk sharing (D89) | Trade (F19) |
| Uncertainty increases expected level of terms of trade (D89) | Trade (F19) |
| Uncertainty allows countries to export more in low-endowment states (D89) | Trade (F19) |