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Consumption, stock returns, and the gains from international risk-sharing

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  • Karen K. Lewis

Abstract

Standard theoretical models predict that domestic residents should diversify their portfolios into foreign assets much more than observed in practice. Whether this lack of diversification is important depends on the potential gains from risk-sharing. General equilibrium models and consumption data tend to find that the costs are small, typically less than 0.5% of permanent consumption. On the other hand, stock returns imply gains that are several hundred times larger. In this paper, the author examines the reasons for these differences and finds that the primary differences are due to (a) the much higher variability of stocks, and/or (b) the higher degree of risk aversion required to reconcile an international equity premium. Furthermore, contrary to conventional wisdom, treating stock returns as exogenous does not necessarily imply greater gains.

Suggested Citation

  • Karen K. Lewis, 1996. "Consumption, stock returns, and the gains from international risk-sharing," Working Papers 96-6, Federal Reserve Bank of Philadelphia.
  • Handle: RePEc:fip:fedpwp:96-6
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    References listed on IDEAS

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    Cited by:

    1. Fernando Alvarez & Urban J. Jermann, 2004. "Using Asset Prices to Measure the Cost of Business Cycles," Journal of Political Economy, University of Chicago Press, vol. 112(6), pages 1223-1256, December.
    2. Mirakhor, Abbas, 2007. "Islamic Finance and Globalization: A Convergence?," MPRA Paper 56026, University Library of Munich, Germany.
    3. Auray, Stéphane & Eyquem, Aurélien & Poutineau, Jean-Christophe, 2010. "The Welfare Gains Of Trade Integration In The European Monetary Union," Macroeconomic Dynamics, Cambridge University Press, vol. 14(05), pages 645-676, November.
    4. Callen, Michael & Imbs, Jean & Mauro, Paolo, 2015. "Pooling risk among countries," Journal of International Economics, Elsevier, vol. 96(1), pages 88-99.
    5. Patrick F. Rowland & Linda L. Tesar, 2004. "Multinationals and the Gains from International Diversification," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 7(4), pages 789-826, October.
    6. Wolfgang Eggert & Maximilian Stephan & Janine Temme & Handirk von Ungern-Sternberg, 2015. "Diversification, Risk Aversion and Expectation in a Holdout Scenario," CESifo Working Paper Series 5527, CESifo Group Munich.
    7. Stefano G. Athanasoulis & Robert J. Shiller, 2001. "World Income Components: Measuring and Exploiting Risk-Sharing Opportunities," American Economic Review, American Economic Association, vol. 91(4), pages 1031-1054, September.

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