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International Consumption Risk Is Shared After All: An Asset Return View

  • Karen K. Lewis
  • Edith X. Liu
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    International consumption risk sharing studies have largely ignored their models' counterfactual implications for asset returns although these returns incorporate direct market measures of risk. In this paper, we modify a canonical risk-sharing model to generate more plausible asset return behavior and then consider the effects on welfare gains. Matching the mean and variance of equity returns and the risk-free rate requires persistent consumption risk, leading to three main findings: (1) risk-sharing gains decrease as the ability to diversify persistent consumption risk decreases; (2) the international correlation of equity returns is high relative to the correlation of consumption and dividends, implying low diversification potential for persistent consumption risk; and (3) increasing persistent consumption risk reduces the gains. Taken together, our findings suggest that asset returns imply more international risk sharing than previously thought.

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    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 17872.

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    Date of creation: Feb 2012
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    Handle: RePEc:nbr:nberwo:17872
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