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Decentralized international risk sharing and governmental moral hazard

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Author Info
Wagner, W. (Tilburg University, Center for Economic Research)
Abstract

This paper studies the issue of moral hazard in the presence of decentralized international risk sharing. In the model presented, risk sharing is achieved through macro markets (markets in which claims to the GDP of a country can be traded). Moral hazard arises for the following reason: if foreigners hold claims to domestic GDP due to risk sharing motives, the country will not receive the full benefit from its production anymore. This can motivate for example a tax on investment (which reduces production) or simply result in reduced governmental effort to increase productivity. We show in a two-country general equilibrium framework that the moral hazard problem does not lead to a reduction in the risk sharing (households hold half of world output). This results ultimately in a 100% tax on investment and creates a huge distortion. We conclude that unregulated macro markets pose a serious threat to world welfare. The analysis also raises concern about the desirability of decentralized risk sharing in general, in particular risk sharing through international trade of equity.

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Paper provided by Tilburg University, Center for Economic Research in its series Discussion Paper with number 92.

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Date of creation: 2000
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Handle: RePEc:dgr:kubcen:200092

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Related research
Keywords: international risk sharing;

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Find related papers by JEL classification:
F30 - International Economics - - International Finance - - - General
G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

References listed on IDEAS
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    Other versions:
  2. Kahn, J.A., 1988. "Moral Hazard, Imperfect Risk-Sharing, And The Behavior Of Asset Returns," RCER Working Papers 152, University of Rochester - Center for Economic Research (RCER).
    Other versions:
  3. Stefano Athanasoulis & Robert Shiller & Eric van Wincoop, 1999. "Macro markets and financial security," Economic Policy Review, Federal Reserve Bank of New York, issue Apr, pages 21-39. [Downloadable!]
  4. Robert J. Shiller & Stefano Athanasoulis, 1995. "World Income Components: Measuring and Exploiting International Risk Sharing Opportunities," NBER Working Papers 5095, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  5. Brander, James A & Spencer, Barbara J, 1989. "Moral Hazard and Limited Liability: Implications for the Theory of the Firm," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 30(4), pages 833-49, November. [Downloadable!] (restricted)
  6. Cole, Harold L. & Obstfeld, Maurice, 1991. "Commodity trade and international risk sharing : How much do financial markets matter?," Journal of Monetary Economics, Elsevier, vol. 28(1), pages 3-24, August. [Downloadable!] (restricted)
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  7. Jamsheed Shorish & Stephen E. Spear, 2005. "Shaking the tree: an agency-theoretic model of asset pricing," Annals of Finance, Springer, vol. 1(1), pages 51-72, 01. [Downloadable!] (restricted)
    Other versions:
  8. Bordignon, Massimo & Manasse, Paolo & Tabellini, Guido, 1996. "Optimal Regional Redistribution Under Asymmetric Information," CEPR Discussion Papers 1437, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  9. Newbery, David M G & Stiglitz, Joseph E, 1982. "The Choice of Techniques and the Optimality of Market Equilibrium with Rational Expectations," Journal of Political Economy, University of Chicago Press, vol. 90(2), pages 223-46, April. [Downloadable!] (restricted)
  10. van Wincoop, Eric, 1999. "How big are potential welfare gains from international risksharing?," Journal of International Economics, Elsevier, vol. 47(1), pages 109-135, February. [Downloadable!] (restricted)
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  11. Sanford J. Grossman & Oliver D. Hart, 1982. "Corporate Financial Structure and Managerial Incentives," NBER Chapters, in: The Economics of Information and Uncertainty, pages 107-140 National Bureau of Economic Research, Inc. [Downloadable!]
  12. Greenwood, Jeremy & Williamson, Stephen D., 1989. "International financial intermediation and aggregate fluctuations under alternative exchange rate regimes," Journal of Monetary Economics, Elsevier, vol. 23(3), pages 401-431, May. [Downloadable!] (restricted)
    Other versions:
  13. Persson, Torsten & Tabellini, Guido, 1996. "Federal Fiscal Constitutions: Risk Sharing and Moral Hazard," Econometrica, Econometric Society, vol. 64(3), pages 623-46, May. [Downloadable!] (restricted)
  14. Bart Taub, 1990. "The Equivalence of Lending Equilibria and Signalling-Based Insurance under Asymmetric Information," RAND Journal of Economics, The RAND Corporation, vol. 21(3), pages 388-408, Autumn. [Downloadable!] (restricted)
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  21. John F. Marshall & Vipul K. Bansal & Anthony F. Herbst & Alan L. Tucker, 1992. "Hedging Business Cycle Risk With Macro Swaps And Options," Journal of Applied Corporate Finance, Morgan Stanley, vol. 4(4), pages 103-108. [Downloadable!] (restricted)
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