Working Paper: CEPR ID: DP688
Authors: Maurice Obstfeld
Abstract: This paper develops a dynamic continuous-time model in which international risk sharing can yield substantial welfare gains through its positive effect on expected consumption growth. The mechanism linking global diversification to growth is an attendant world portfolio shift from safe, but low-yield, capital into riskier, high-yield capital. The presence of these two types of capital is designed to capture the idea that growth depends on the availability of an ever-increasing array of specialized, and hence inherently risky, production inputs. A partial calibration exercise based on Penn World Table consumption data implies steady-state welfare gains from global financial integration, which for some regions amount to several times initial wealth.
Keywords: economic growth; international financial markets; international portfolio diversification
JEL Codes: G15; O40
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| international risk sharing (F30) | expected consumption growth (E20) |
| portfolio diversification (G11) | expected consumption growth (E20) |
| portfolio diversification (G11) | national welfare (I39) |
| shift from low-yield to high-yield capital (F21) | expected growth rates (O40) |
| opening asset markets to trade (G15) | expected consumption growth (E20) |
| opening asset markets to trade (G15) | national welfare (I39) |
| diversifying portfolios (G11) | expected growth (O40) |
| imperfect correlation of risky returns (G19) | effects on growth and welfare (F62) |
| decision to invest in risky vs safe projects (G11) | portfolio shift towards riskier investments (G11) |