DP5820 Globalization and Risk Sharing

Author(s): Fernando A Broner, Jaume Ventura
Publication Date: September 2006
Keyword(s): domestic markets, globalization, international markets, risk sharing, sovereign risk
JEL(s): F34, F36, G15
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=5820

This paper presents a theoretical study of the effects of globalization on risk sharing and welfare. We model globalization as a gradual and exogenous increase in the fraction of goods that are tradable. In the absence of frictions, globalization opens new goods markets and raises welfare. We assume, however, that countries cannot commit to pay their debts. Unlike the previous literature, and motivated by changes in the institutional setup of emerging-market borrowing, we also assume that countries cannot discriminate between domestic and foreign creditors when paying their debts. Although globalization still opens new goods markets, we find that it can also open or close some asset markets. The net effect on risk sharing and welfare of this process of creation and destruction of markets might be either positive or negative depending on a variety of factors that the theory highlights.