Advanced Search
MyIDEAS: Login to save this paper or follow this series

high level of international risk sharing when the productivity growth contains long run risk

Contents:

Author Info

  • Chang, Yanqin

Abstract

This theoretical paper investigates international risk sharing and its implications for equity home bias. A general equilibrium model, featuring two closed economies with nontrivial production sectors, is developed. Moreover, productivity contains a small but persistent highly correlated long run risk that becomes the major determinant of the intertemporal marginal rate of substitution (IMRS) in a model with the recursive preferences. Despite adopting the model of closed economies and autarkic asset holdings—a scenario leading to the lowest level of international risk sharing under the same conditions—our model is still able to generate international risk sharing indexes always over 96% for a broad range of parameter values, excepting two cases: where the elasticity of intertemporal substitution (EIS) is the reciprocal of the relative risk aversion (RRA); and where EIS is around 0.7. In those cases, the risk sharing index drops sharply to about 30%. This result sheds light on why the benchmark model, featuring a power utility whereby EIS is the reciprocal of RRA, generates international risk sharing as low as 30%. However, when EIS takes these values, our model’s results cannot be reconciled with asset market data-model yields low volatility of the logarithms of IMRS, even lower than Hansen-Jagannathan lower bound. The implication is that the low proportion of foreign assets in a domestic agent’s portfolio, a phenomenon observed in the data, might not be a puzzle or a departure from the agent's optimality condition. After all, risk has already been well shared internationally due to the high correlations across countries of the long run productivity shocks. Hence, there is not much incentive left for an agent to hold foreign assets in her portfolio to further share the risk internationally. Therefore, equity home bias might not be a puzzle as claimed by the benchmark model, in the sense that it can be adequately reconciled with our theoretical result

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://mpra.ub.uni-muenchen.de/4476/
File Function: original version
Download Restriction: no

Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 4476.

as in new window
Length:
Date of creation: Sep 2007
Date of revision:
Handle: RePEc:pra:mprapa:4476

Contact details of provider:
Postal: Schackstr. 4, D-80539 Munich, Germany
Phone: +49-(0)89-2180-2219
Fax: +49-(0)89-2180-3900
Web page: http://mpra.ub.uni-muenchen.de
More information through EDIRC

Related research

Keywords: International risk sharing; production; long run risk; recursive preferences;

Find related papers by JEL classification:

This paper has been announced in the following NEP Reports:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Campbell, John, 1994. "Inspecting the Mechanism: An Analytical Approach to the Stochastic Growth Model," Scholarly Articles 3196342, Harvard University Department of Economics.
  2. Mariano M. Croce, 2006. "Welfare Costs, Long Run Consumption Risk, and a Production Economy," 2006 Meeting Papers, Society for Economic Dynamics 582, Society for Economic Dynamics.
  3. Eberly, Janice C., 1997. "International evidence on investment and fundamentals," European Economic Review, Elsevier, Elsevier, vol. 41(6), pages 1055-1078, June.
  4. Philippe Weil, 1989. "The Equity Premium Puzzle and the Riskfree Rate Puzzle," NBER Working Papers 2829, National Bureau of Economic Research, Inc.
  5. Fama, Eugene F., 1984. "Forward and spot exchange rates," Journal of Monetary Economics, Elsevier, Elsevier, vol. 14(3), pages 319-338, November.
  6. Campbell, John Y., 2003. "Consumption-based asset pricing," Handbook of the Economics of Finance, Elsevier, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 13, pages 803-887 Elsevier.
  7. Riccardo Colacito & Mariano Croce, 2005. "Risks For The Long Run And The Real Exchange Rate," 2005 Meeting Papers, Society for Economic Dynamics 794, Society for Economic Dynamics.
  8. Lars Peter Hansen & Ravi Jagannathan, 1990. "Implications of security market data for models of dynamic economies," Discussion Paper / Institute for Empirical Macroeconomics, Federal Reserve Bank of Minneapolis 29, Federal Reserve Bank of Minneapolis.
  9. Backus, David K & Kehoe, Patrick J & Kydland, Finn E, 1992. "International Real Business Cycles," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 100(4), pages 745-75, August.
  10. M. Fatih Guvenen, 2002. "Reconciling Conflicting Evidence on the Elasticity of Intertemporal Substitution: A Macroeconomic Perspective," RCER Working Papers, University of Rochester - Center for Economic Research (RCER) 491, University of Rochester - Center for Economic Research (RCER), revised Mar 2003.
  11. Michele Boldrin & Lawrence J. Christiano & Jonas D. M. Fisher, 2000. "Habit persistence, asset returns and the business cycle," Staff Report, Federal Reserve Bank of Minneapolis 280, Federal Reserve Bank of Minneapolis.
  12. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, Econometric Society, vol. 50(6), pages 1345-70, November.
  13. Harald Uhlig, 1995. "A toolkit for analyzing nonlinear dynamic stochastic models easily," Discussion Paper / Institute for Empirical Macroeconomics, Federal Reserve Bank of Minneapolis 101, Federal Reserve Bank of Minneapolis.
  14. Hanno Lustig & Stijn Van Nieuwerburgh, 2005. "The Returns on Human Capital: Good News on Wall Street is Bad News on Main Street," NBER Working Papers 11564, National Bureau of Economic Research, Inc.
  15. David K. Backus & Patrick J. Kehoe & Finn E. Kydland, 1993. "International business cycles: theory vs. evidence," Quarterly Review, Federal Reserve Bank of Minneapolis, Federal Reserve Bank of Minneapolis, issue Fall, pages 14-29.
  16. Thomas Tallarini, . "Risk-Sensitive Real Business Cycles," GSIA Working Papers, Carnegie Mellon University, Tepper School of Business 1997-35, Carnegie Mellon University, Tepper School of Business.
  17. David K. Backus, 2001. "Affine Term Structure Models and the Forward Premium Anomaly," Journal of Finance, American Finance Association, American Finance Association, vol. 56(1), pages 279-304, 02.
  18. Backus, David K. & Smith, Gregor W., 1993. "Consumption and real exchange rates in dynamic economies with non-traded goods," Journal of International Economics, Elsevier, Elsevier, vol. 35(3-4), pages 297-316, November.
  19. Robert E. Hall, 1981. "Intertemporal Substitution in Consumption," NBER Working Papers 0720, National Bureau of Economic Research, Inc.
  20. Ravi Bansal & Amir Yaron, 2000. "Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles," NBER Working Papers 8059, National Bureau of Economic Research, Inc.
  21. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
  22. Carlo Favero, 2005. "Consumption, Wealth, the Elasticity of Intertemporal Substitution and Long-Run Stock Market Returns," Working Papers, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University 291, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  23. Attanasio, Orazio P & Weber, Guglielmo, 1989. "Intertemporal Substitution, Risk Aversion and the Euler Equation for Consumption," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 99(395), pages 59-73, Supplemen.
Full references (including those not matched with items on IDEAS)

Citations

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:pra:mprapa:4476. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Ekkehart Schlicht).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.