International financial equilibrium with risk sharing and private information

  • Bart Taub
Chapter
Part of the Studies in Economic Theory book series (ECON.THEORY, volume 8)

Abstract

There are two economies. Within each economy individuals undergo idiosyncratic and common shocks to their endowments. The idiosyncratic shocks are independent across individuals and as such can be pooled, providing perfect mutual insurance. The common shocks are not internally insurable. The two countries can trade risk in the conmnon shocks however, and standard ideas about trade in goods apply: there is a price of foreign risk in terms of domestic risk, and beneficial trade occurs at this price. The standard idea that small countries benefit from trade goes through in the risk domain as well.

The mutual benefits of trade in risk can collapse if information about the idiosyncratic endowment processes is private. In that instance an information-eliciting contract can provide insurance of the idiosyncratic endowment processes even under autarky. However, if the two countries open to trade in the common risk processes the domestic information contracts are affected; the degree of insurance can be reduced because of spillover from the effects of the international risk sharing. The desire to insure both idiosyncratic and common shocks can conflict to the point that one country prefers autarky. In contrast to the standard result, the benefits of trade can shrink and become negative as country size shrinks. These findings would be somewhat academic were it not for the fact that within the model, the information-eliciting contract generates a dynamic allocation identical to that of an asset equilibrium. Thus, a theoretical foundation exists for countries rationally restricting trade in assets.

JEL Classification Numbers

G15 

Keywords

International financial equilibrium risk sharing 
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Copyright information

© Springer-Verlag Berlin Heidelberg 1999

Authors and Affiliations

  • Bart Taub
    • 1
  1. 1.Department of EconomicsUniversity of Illinois at ChampaignChampaignUSA

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