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Sharing Asymmetric Tail Risk Smoothing, Asset Pricing and Terms of Trade

Giancarlo Corsetti, Anna Lipińska and Giovanni Lombardo

Cambridge Working Papers in Economics from Faculty of Economics, University of Cambridge

Abstract: With the Global Financial Crisis, the COVID-19 pandemic, and the looming Climate Change, investors and policymakers around the world are bracing for a new global environment with heightened tail risk. Asymmetric exposure to this risk across countries raises the private and social value of arrangements improving insurance. We offer an analytical decomposition of the welfare effects of efficient capital market integration into a "smoothing" and a "level effect". Enhancing risk sharing affects the volatility of consumption, but also brings about equilibrium adjustment in asset and goods prices. This in turn drives relative wealth and consumption, as well as labor and capital allocation, across borders. Using model simulation, we explore quantitatively the empirical relevance of the different channels through which riskier and safer countries benefit from sharing macroeconomic risk. We offer an algorithm for the correct solution of the equilibrium using DSGE models under complete markets, at higher order of approximation.

Keywords: International Risk Sharing; Asymmetry; Fat Tails; Welfare; Transfer Problem (search for similar items in EconPapers)
JEL-codes: F15 F41 G15 (search for similar items in EconPapers)
Date: 2021-07-26
New Economics Papers: this item is included in nep-dge, nep-fdg, nep-opm and nep-rmg
Note: gc422
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Working Paper: Sharing asymmetric tail risk smoothing, asset pricing and terms of trade (2021) Downloads
Working Paper: Sharing Asymmetric Tail Risk: Smoothing, Asset Pricing and Terms of Trade (2021) Downloads
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