Working Paper: NBER ID: w3027
Authors: Harold L. Cole; Maurice Obstfeld
Abstract: This paper evaluates the gains from international risk sharing in some simple general-equilibrium models with output uncertainty. Under empirically plausible calibration, the Incremental loss from a ban on international portfolio diversification is estimated to be quite small--0.15 percent of output per year is a representative figure. Even the theoretical gains from asset trade may disappear under alternative sets of assumptions on preferences and technology. The paper argues that the small magnitude of potential trade gains, when coupled with small costs of cross-border financial transactions, may explain the apparently inconsistent findings of empirical studies on the degree of international capital mobility.
Keywords: International Risk Sharing; Portfolio Diversification; Financial Markets; General Equilibrium Models
JEL Codes: F30; F36; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| welfare gains from international risk sharing are small (D69) | loss from banning international portfolio diversification is unlikely to exceed 0.15% of average national product per year (F69) |
| minor barriers to asset trade can completely wipe out the already small gains from diversification (G15) | effectiveness of international risk sharing (F30) |
| fluctuations in international terms of trade (F14) | negative correlation between a country's output growth rate and its terms of trade (F14) |
| negative correlation between a country's output growth rate and its terms of trade (F14) | fluctuations can act as insurance against output shocks (E32) |