International Diversification, Growth, and Welfare with Non-Traded Income Risk and Incomplete Markets

Egil Matsen

Working Paper Series from Department of Economics, Norwegian University of Science and Technology

Abstract: We ask how the potential benefits from cross-border asset trade are affected by the presence of non-traded income risk in incomplete markets. We show that the mean consumption growth may be lower with full integration than in financial autarky. This can occur because: the hedging demand for risky high-return projects may fall as the investment opportunity set increases, and precautionary savings may fall as the unhedgeable non-traded income variance decreases upon financial integration. We also show that international asset trade increases welfare if it increases the risk-adjusted growth rate. This is always the case in our model, but the effect may be close to negligible. The welfare gain is smaller the higher the correlation between the domestic non-traded income process and foreign asset returns.

Keywords: Incomplete markets; financial integration; growth; welfare (search for similar items in EconPapers)
JEL-codes: E44 F36 G15 (search for similar items in EconPapers)
Pages: 29 pages
Date: 2002-10
New Economics Papers: this item is included in nep-cfn, nep-mac and nep-rmg
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http://www.svt.ntnu.no/iso/WP/2002/17NT_25_sep_00.pdf (application/pdf)

Related works:
Journal Article: International diversification, growth, and welfare with non-traded income risk and incomplete markets (2005)
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Persistent link: https://EconPapers.repec.org/RePEc:nst:samfok:1702

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