International Diversification, Growth, and Welfare with Non-Traded Income Risk and Incomplete Markets
AbstractWe ask how the potential benefits from cross-border asset trade are affected by the presence of non-traded income risk in incomplete markets. We show that the mean consumption growth may be lower with full integration than in financial autarky. This can occur because: the hedging demand for risky high-return projects may fall as the investment opportunity set increases, and precautionary savings may fall as the unhedgeable non-traded income variance decreases upon financial integration. We also show that international asset trade increases welfare if it increases the risk-adjusted growth rate. This is always the case in our model, but the effect may be close to negligible. The welfare gain is smaller the higher the correlation between the domestic non-traded income process and foreign asset returns.
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Bibliographic InfoPaper provided by Department of Economics, Norwegian University of Science and Technology in its series Working Paper Series with number 1702.
Length: 29 pages
Date of creation: Oct 2002
Date of revision:
Incomplete markets; financial integration; growth; welfare;
Other versions of this item:
- Egil Matsen, 2005. "International diversification, growth, and welfare with non-traded income risk and incomplete markets," Applied Financial Economics, Taylor & Francis Journals, vol. 15(15), pages 1063-1072.
- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
- F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
- G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
This paper has been announced in the following NEP Reports:
- NEP-ALL-2003-04-27 (All new papers)
- NEP-CFN-2003-04-27 (Corporate Finance)
- NEP-MAC-2003-04-27 (Macroeconomics)
- NEP-RMG-2003-04-27 (Risk Management)
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