Demand Risk and Diversification through Trade

Federico Esposito

MPRA Paper from University Library of Munich, Germany

Abstract: I develop a theory of risk diversification through geography, where risk-averse entrepreneurs exploit the spatial correlation of demand across countries to lower the variance of sales. Both the probability of entry and trade flows to a market are increasing in the “Diversification Index”, which depends on the multilateral covariance of a country's demand with all other markets. The firms’ risk diversification behavior may imply higher welfare gains from trade than in standard trade models. Risk-augmented gravity regressions show that demand risk significantly affects trade patterns. The risk diversification channel increases welfare gains from trade by 16% relative to models with risk neutrality. The quantitative application highlights the role of demand uncertainty in shaping the economic consequences of the recent Chinese boom.

Keywords: Demand risk; gravity; risk diversification; welfare gains from trade; China shock (search for similar items in EconPapers)
JEL-codes: F1 F10 F12 F6 F60 (search for similar items in EconPapers)
Date: 2019-12-05
New Economics Papers: this item is included in nep-gen and nep-int
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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https://mpra.ub.uni-muenchen.de/99875/1/MPRA_paper_99875.pdf original version (application/pdf)
https://mpra.ub.uni-muenchen.de/100039/8/MPRA_paper_100039.pdf revised version (application/pdf)
https://mpra.ub.uni-muenchen.de/100398/8/MPRA_paper_100039.pdf revised version (application/pdf)
https://mpra.ub.uni-muenchen.de/100398/15/MPRA_paper_100398.pdf revised version (application/pdf)

Related works:
Working Paper: Demand Risk and Diversification through Trade (2020)
Working Paper: Demand Risk and Diversification through Trade (2019)
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