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Title: Global Risk Sharing through Trade in Goods and Assets: Theory and Evidence

Author(s): Inga Heiland

Publication Date: December 2019

Keyword(s): Global Risk Sharing, international trade and structural gravity

Programme Area(s): International Trade and Regional Economics

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.

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Bibliographic Reference

Heiland, I. 2019. 'Global Risk Sharing through Trade in Goods and Assets: Theory and Evidence'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=14230