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Volatility and the Gains from Trade

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  • Treb Allen
  • David Atkin

Abstract

By reducing the negative correlation between local prices and productivity shocks, trade liberalization changes the volatility of returns. In this paper, we explore the second moment effects of trade. Using forty years of agricultural micro-data from India, we show that falling trade costs increased farmer's revenue volatility, causing farmers to shift production toward crops with less risky yields. We then characterize how volatility affects farmer's crop allocation using a portfolio choice framework where returns are determined in general equilibrium by a many-location, many-good Ricardian trade model with flexible trade costs. Finally, we structurally estimate the model—recovering farmers' unobserved risk-return preferences from the gradient of the mean-variance frontier at their observed crop choice—to quantify the second moment effects of trade. While the expansion of the Indian highway network would have increased the volatility of farmer's real income had their crop choice remained constant, by changing what they produced farmers were able to avoid this increased volatility and amplify the gains from trade.

Suggested Citation

  • Treb Allen & David Atkin, 2016. "Volatility and the Gains from Trade," NBER Working Papers 22276, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:22276
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    References listed on IDEAS

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    1. Francesco Caselli & Miklós Koren & Milan Lisicky & Silvana Tenreyro, 2020. "Diversification Through Trade," The Quarterly Journal of Economics, Oxford University Press, vol. 135(1), pages 449-502.
    2. Helpman, Elhanan & Razin, Assaf, 1979. "A Theory of International Trade Under Uncertainty," Elsevier Monographs, Elsevier, edition 1, number 9780123396501 edited by Shell, Karl.
    3. Jose Asturias & Manuel García-Santana & Roberto Ramos, 2019. "Competition and the Welfare Gains from Transportation Infrastructure: Evidence from the Golden Quadrilateral of India," Journal of the European Economic Association, European Economic Association, vol. 17(6), pages 1881-1940.
    4. Treb Allen, 2014. "Information Frictions in Trade," Econometrica, Econometric Society, vol. 82, pages 2041-2083, November.
    5. Karabay, Bilgehan & McLaren, John, 2010. "Trade, offshoring, and the invisible handshake," Journal of International Economics, Elsevier, vol. 82(1), pages 26-34, September.
    6. Priya Basu, 2006. "Improving Access to Finance for India's Rural Poor," World Bank Publications, The World Bank, number 6927, Juni.
    7. Robin Burgess & Rohini Pande, 2005. "Do Rural Banks Matter? Evidence from the Indian Social Banking Experiment," American Economic Review, American Economic Association, vol. 95(3), pages 780-795, June.
    8. Seema Jayachandran, 2006. "Selling Labor Low: Wage Responses to Productivity Shocks in Developing Countries," Journal of Political Economy, University of Chicago Press, vol. 114(3), pages 538-575, June.
    9. Fulford, Scott L., 2013. "The effects of financial development in the short and long run: Theory and evidence from India," Journal of Development Economics, Elsevier, vol. 104(C), pages 56-72.
    10. Robin Burgess & Dave Donaldson, 2010. "Can Openness Mitigate the Effects of Weather Shocks? Evidence from India's Famine Era," American Economic Review, American Economic Association, vol. 100(2), pages 449-453, May.
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    Citations

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    Cited by:

    1. Heiland, Inga, 2016. "Global Risk Sharing Through Trade in Goods and Assets: Theory and Evidence," Annual Conference 2016 (Augsburg): Demographic Change 145821, Verein für Socialpolitik / German Economic Association.
    2. Esposito, Federico, 2019. "Demand Risk and Diversification through Trade," MPRA Paper 99875, University Library of Munich, Germany.
    3. Magrini, Emiliano & Montalbano, Pierluigi & Winters, L. Alan, 2018. "Households’ vulnerability from trade in Vietnam," World Development, Elsevier, vol. 112(C), pages 46-58.
    4. Luca Salvatici & Silvia Nenci, 2017. "New features, forgotten costs and counterfactual gains of the international trading system," European Review of Agricultural Economics, Foundation for the European Review of Agricultural Economics, vol. 44(4), pages 592-633.
    5. Chatterjee, S., 2019. "Market Power and Spatial Competition in Rural India," Cambridge Working Papers in Economics 1921, Faculty of Economics, University of Cambridge.
    6. Esposito, Federico, 2020. "Demand Risk and Diversification through International Trade," MPRA Paper 100865, University Library of Munich, Germany.
    7. David Atkin & Amit Khandelwal, 2019. "How Distortions Alter the Impacts of International Trade in Developing Countries," NBER Working Papers 26230, National Bureau of Economic Research, Inc.
    8. Francisco Costa & Fabien Forge & Jason Garred & João Paulo Pessoa, 2020. "Climate Change and the Distribution of Agricultural Output," Working Papers 2003E, University of Ottawa, Department of Economics.

    More about this item

    JEL classification:

    • F1 - International Economics - - Trade
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • O13 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Agriculture; Natural Resources; Environment; Other Primary Products
    • O18 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Urban, Rural, Regional, and Transportation Analysis; Housing; Infrastructure

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