World Income Components: Measuring and Exploiting Risk-Sharing Opportunities

Stefano G. Athanasoulis and Robert Shiller
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Stefano G. Athanasoulis: Yale University, https://economics.yale.edu/

No 1239, Cowles Foundation Discussion Papers from Cowles Foundation for Research in Economics, Yale University

Abstract: We provide a method for decomposing the variance of changes in incomes in the world into components, world income components (WICs), in such a way as to indicate the most important risk-sharing opportunities among people of the world. We develop a constant absolute risk premium model, an intertemporal general equilibrium model of the world that facilitates consideration of optimal contract design. We show that for a contract designer maximizing a social welfare function, the optimal risk-management contracts maximize the equilibrium world real interest rate. That is the contract designer achieves the risk-optimal interest rate. We show that these WIC securities are defined in terms of eigenvectors of a transformed variance matrix of income changes. The method is applied with a variance matrix estimated using Penn World Table data on the G-7 countries, 1950-92.

Keywords: Constant Absolute Risk Premium; risk-optimal interest rate; three-level income model; WIC securities; contract design; macro markets; hedging (search for similar items in EconPapers)
Pages: 43 pages
Date: 1999-10
Note: CFP 1029.
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Citations: View citations in EconPapers (6)

Published in The American Economic Review (2001), 91(4): 1031-1054

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