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Pooling Risk Among Countries

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  • Jean Imbs
  • Paolo Mauro

Abstract

In this paper, we identify the groups of countries where international risk-sharing opportunities are most attractive. We show that the bulk of risk-sharing gains can be achieved in groups consisting of as few as seven members, and that further marginal benefits quickly become negligible. For many such small groups, the welfare gains associated with risk sharing can amount to one order of magnitude larger than Lucas''s classic calibration suggested for the United States, under similar assumptions on utility. Why do we not observe more arrangements of this type? Large welfare gains can only be achieved within groups where contracts are probably seen as relatively difficult to enforce. International diversification can thus yield substantial gains, but these may remain untapped owing to potential partners'' weak institutional quality and a history of default on international obligations. Noting that existing risk sharing arrangements often have a regional dimension, we speculate that shared economic interests such as common trade may help sustain such arrangements, though risk-sharing gains are smaller when membership is constrained on a regional basis.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 07/132.

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Length: 50
Date of creation: 01 Jun 2007
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Handle: RePEc:imf:imfwpa:07/132

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Keywords: Export diversification; Financial risk; Trade integration; risk sharing; standard deviation; emerging markets; samples; covariances; risk diversification; covariance; statistics; random walk; arithmetic; correlation; correlations; combinatorial analysis; risk aversion; standard deviations; economic risks; calibration; optimization; mathematical programming; random samples; separability;

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Cited by:
  1. Yuliya Demyanyk & Vadym Volosovych, 2006. "Gains from Financial Integration in the European Union: Evidence for New and Old Members," Working Papers, Department of Economics, College of Business, Florida Atlantic University 06009, Department of Economics, College of Business, Florida Atlantic University, revised Aug 2007.
  2. Fecht, Falko & Grüner, Hans Peter & Hartmann, Philipp, 2012. "Financial integration, specialization, and systemic risk," Journal of International Economics, Elsevier, Elsevier, vol. 88(1), pages 150-161.
  3. Suman S. Basu & Ran Bi & Prakash Kannan, 2010. "Regional reserve pooling arrangements," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue Oct.
  4. Kose, M. Ayhan & Prasad, Eswar S. & Terrones, Marco E., 2009. "Does financial globalization promote risk sharing?," Journal of Development Economics, Elsevier, Elsevier, vol. 89(2), pages 258-270, July.

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