Risk and Risk Aversion Trade Content, Gains from Trade and Trade Policy

Using a simple duopolistic trade model with demand uncertainty and an identical traded product, we show that we can view trade in goods as implicit exports/imports of risk and risk aversion. Specifically, we show that a relatively “risk-aversion abundant” country is more likely to be a net importer of the product – hence an importer of low risk-aversion. Similarly, a “relatively high-risk abundant” country is more likely to be the net exporter of the product - hence an importer of low risk. We also show that market correlations and differences in risk aversion and risk are sources of implicit risk-sharing and diversification gains from trade. Consequently, the relatively high-risk or high-risk-aversion country always gains from trade, whereas the other country will most likely gain unless markets are highly positively correlated. Furthermore, we re-examine the (Brander-Spencer) strategic export subsidy game in the context of uncertainty and find that because both efficient risk management and rent shifting need to be considered, contrary to conventional wisdom, the equilibrium policy regime may be an export tax rather than a subsidy.