DP14230 Global Risk Sharing through Trade in Goods and Assets: Theory and Evidence

Author(s): Inga Heiland
Publication Date: December 2019
Date Revised: November 2020
Keyword(s): Global Risk Sharing, international trade, structural gravity
JEL(s): F15, F36, F44, G11
Programme Areas: International Trade and Regional Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14230

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.