Volatility and the Gains from Trade

Treb Allen and David Atkin

No 22276, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Trade liberalization changes the volatility of returns by reducing the negative correlation between local prices and productivity shocks. In this paper, we explore these second moment effects of trade. Using forty years of agricultural micro-data from India, we show that falling trade costs due to expansions of the Indian highway network reduced the responsiveness of local prices to local rainfall but increased the responsiveness of local prices to prices elsewhere. In response, farmers shifted their production toward crops with less volatile yields, especially so for those with poor access to risk mitigating technologies such as banks. We then characterize how volatility affects farmer's crop allocation using a portfolio choice framework where returns are determined in general equilibrium by a many-location, many-good Ricardian trade model with flexible trade costs. Finally, we structurally estimate the model—recovering farmers' risk-return preferences from the gradient of the mean-variance frontier at their observed crop choices—to quantify the second moment effects of trade. We find that first moment gains from specialization dominate second moment effects on average and that improvements in risk-mitigating technologies would encourage farmers to take advantage of higher-risk higher-return allocations, with the strength of these effects hinging on whether the riskiest crops are also the comparative advantage ones.

JEL-codes: F1 G11 O13 O18 (search for similar items in EconPapers)
Date: 2016-05
New Economics Papers: this item is included in nep-int
Note: DEV ITI
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Citations: View citations in EconPapers (40)

Published as Treb Allen & David Atkin, 2022. "Volatility and the Gains From Trade," Econometrica, Econometric Society, vol. 90(5), pages 2053-2092, September.

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