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World Income Components: Measuring and Exploting International Risk Sharing Opportunities

  • Athanasoulis, S.
  • Shiller, R.J.

We provide methods of decomposing the variance of world national incomes into components in such a way as to indicate the most important risk-sharing opportunities, and, therefore, the most important missing international risk markets to establish. One method uses a total variance reduction criterion, and identified risk-sharing opportunities in terms of eigenvectors of a variance matrix of residuals produced when country incomes are regressed on world income. Another method uses a mean-variance utility-maximizing criterion and identifies risk-sharing opportunities in terms of eigenvectors of a variance matrix of deviations of country incomes from their respective contract-year shares of world income. The two methods are applied using Summers-Heston [1991] data on national incomes for large countries 1950-1990, each using two different methods of estimating variances. While these data are not sufficient to provide accurate estimates of the requisite variance matrices of (transformed) national incomes, the results are suggestive of important new markets that could actually be created, and show that there may be large welfare gains to creating some of these markets.

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Paper provided by Yale - Economic Growth Center in its series Papers with number 725.

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Length: 69 pages
Date of creation: 1995
Date of revision:
Handle: RePEc:fth:yalegr:725
Contact details of provider: Postal: U.S.A.; YALE UNIVERSITY, ECONOMIC GROWTH CENTER, YALE STATION NEW-HAVEN CONNECTICUT 06520 U.S.A
Phone: (203) 432-3610
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Web page: http://www.econ.yale.edu/~egcenter/
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  1. Danny Quah & Thomas J. Sargent, 1992. "A dynamic index model for large cross sections," Discussion Paper / Institute for Empirical Macroeconomics 77, Federal Reserve Bank of Minneapolis.
  2. Andrew Atkeson & Christopher Phelan, 1994. "Reconsidering the Costs of Business Cycles with Incomplete Markets," NBER Working Papers 4719, National Bureau of Economic Research, Inc.
  3. Robert J. Shiller, 1992. "Measuring Asset Values for Cash Settlement in Derivative Markets: Hedonic Repeated Measures Indices and Perpetual Futures," Cowles Foundation Discussion Papers 1036, Cowles Foundation for Research in Economics, Yale University.
  4. Sachs, Jeffrey & Sala-i-Martin, Xavier, 1992. "Fiscal Federalism and Optimum Currency Areas: Evidence for Europe from the United States," CEPR Discussion Papers 632, C.E.P.R. Discussion Papers.
  5. Harold L. Cole & Maurice Obstfeld, 1989. "Commodity Trade and International Risk Sharing: How Much Do Financial Markets Matter?," NBER Working Papers 3027, National Bureau of Economic Research, Inc.
  6. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
  7. Gyutaeg Oh, 1996. "Some Results in the CAPM with Nontraded Endowments," Management Science, INFORMS, vol. 42(2), pages 286-293, February.
  8. Summers, Robert & Heston, Alan, 1991. "The Penn World Table (Mark 5): An Expanded Set of International Comparisons, 1950-1988," The Quarterly Journal of Economics, MIT Press, vol. 106(2), pages 327-68, May.
  9. Maurice Obstfeld, 1992. "Risk-taking, global diversification, and growth," Discussion Paper / Institute for Empirical Macroeconomics 61, Federal Reserve Bank of Minneapolis.
  10. Athanasoulis, Stefano G & Shiller, Robert J, 2000. "The Significance of the Market Portfolio," Review of Financial Studies, Society for Financial Studies, vol. 13(2), pages 301-29.
  11. Maurice Obstfeld, 1994. "Are Industrial-Country Consumption Risks Globally Diversified?," NBER Working Papers 4308, National Bureau of Economic Research, Inc.
  12. Brennan, M. J. & Solnik, B., 1989. "International risk sharing and capital mobility," Journal of International Money and Finance, Elsevier, vol. 8(3), pages 359-373, September.
  13. Obstfeld, Maurice, 1994. "Evaluating risky consumption paths: The role of intertemporal substitutability," European Economic Review, Elsevier, vol. 38(7), pages 1471-1486, August.
  14. Obstfeld, Maurice, 1992. "International risk sharing and capital mobility: another look," Journal of International Money and Finance, Elsevier, vol. 11(1), pages 115-121, February.
  15. Thomas J. Sargent & Christopher A. Sims, 1977. "Business cycle modeling without pretending to have too much a priori economic theory," Working Papers 55, Federal Reserve Bank of Minneapolis.
  16. Paul M Romer, 1999. "Endogenous Technological Change," Levine's Working Paper Archive 2135, David K. Levine.
  17. Duffie Darrell & Rahi Rohit, 1995. "Financial Market Innovation and Security Design: An Introduction," Journal of Economic Theory, Elsevier, vol. 65(1), pages 1-42, February.
  18. Geanakoplos, John, 1990. "An introduction to general equilibrium with incomplete asset markets," Journal of Mathematical Economics, Elsevier, vol. 19(1-2), pages 1-38.
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