World Income Components: Measuring and Exploiting International Risk Sharing Opportunities

Robert Shiller and Stefano G. Athanasoulis
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Stefano G. Athanasoulis: Iowa State University

No 1097, Cowles Foundation Discussion Papers from Cowles Foundation for Research in Economics, Yale University

Abstract: We provide methods of decomposing the variance of world national incomes into components in such a way as to indicate the most important risk-sharing opportunities, and, therefore, the most important missing international risk markets to establish. One method uses a total variance reduction criterion, and identified risk-sharing opportunities in terms of eigenvectors of a variance matrix of residuals produced when country incomes are regressed on world income. Another method uses a mean-variance utility-maximizing criterion and identifies risk-sharing opportunities in terms of eigenvectors of a variance matrix of deviations of country incomes from their respective contract-year shares of world income. The two methods are applied using Summers-Heston [1991] data on national incomes for large countries 1950-1990, each using two different methods of estimating variances. While these data are not sufficient to provide accurate estimates of the requisite variance matrices of (transformed) national incomes, the results are suggestive of important new markets that could actually be created, and show that there may be large welfare gains to creating some of these markets.

Pages: 32 pages
Date: 1997-06
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Published in American Economic Review (September 2001), 91(4): 1031-1054

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Related works:
Working Paper: World Income Components: Measuring And Exploiting International Risk Sharing Opportunities (2004)
Working Paper: World Income Components: Measuring and Exploting International Risk Sharing Opportunities (1995)
Working Paper: World Income Components: Measuring and Exploiting International Risk Sharing Opportunities (1995)
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