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A Note on Risk Sharing versus Instability in International Financial Integration: When Obstfeld Meets Stiglitz

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Abstract

International risk sharing is one of the main arguments in favor of financial liberalization. The pure risk sharing mechanism highlighted by Obstfeld (1994) implies that liberalization is growth enhancing for all countries as it allows the world portfolio to shift from safe low-yield capital to riskier high yield capital. This result is obtained under the assumption that the volatility figures for risky assets prevailing under autarky are not altered after liberalization. This note relaxes this assumption within the standard two-country model with intertemporal portfolio choices, formally incorporating the instability effect invoked by Stiglitz (2000). We show that putting together the pure risk sharing and instability effects in the latter set-up enriches the analysis and delivers predictions more consistent with the contrasted related empirical literature.

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  • Raouf Boucekkine & Benteng Zou, 2017. "A Note on Risk Sharing versus Instability in International Financial Integration: When Obstfeld Meets Stiglitz," AMSE Working Papers 1730, Aix-Marseille School of Economics, France.
    • Handle: RePEc:aim:wpaimx:1730
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    Keywords

    optimal growth; financial liberalization; risk sharing; volatility;
    All these keywords.

    JEL classification:

    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance
    • O41 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - One, Two, and Multisector Growth Models

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