Working Paper: CEPR ID: DP6461
Authors: Jean Imbs; Paolo Mauro
Abstract: We identify the groups of countries where international risk-sharing opportunities are most attractive. We show that the bulk of risk-sharing gains can be achieved in groups consisting of as few as seven members, and that further marginal benefits quickly become negligible. For many such small groups, the welfare gains associated with risk sharing are far larger than Lucas¡¦s classic calibration suggested for the United States, under similar assumptions on utility. Why do we not observe more arrangements of this type? Our results suggest that large welfare gains can only be achieved within groups where contracts are relatively difficult to enforce. International diversification can thus yield substantial gains, but they may remain untapped owing to potential partners¡¦weak institutional quality and a history of default on international obligations. Noting that existing risk-sharing arrangements often have a regional dimension, we speculate that shared economic interests such as common trade may help sustain such arrangements, though risk-sharing gains are smaller when membership is constrained on a regional basis.
Keywords: diversification; enforceability; risk sharing
JEL Codes: E21; E32; E34; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Pooling risk among countries (F34) | sizable welfare gains (D69) |
| Small groups of countries (F53) | sizable welfare gains (D69) |
| High institutional quality (L15) | smaller potential diversification gains (G11) |
| Enforcement difficulties (P37) | complex relationship with risk-sharing arrangements (G32) |
| Shared economic interests (P33) | sustain risk-sharing arrangements (G32) |
| Contract enforceability (K12) | effectiveness of risk-sharing arrangements (G32) |