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Trade Costs, Limited Enforcement and Risk Sharing: A Joint Test

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  • Doireann Fitzgerald

    () (Economics University of California, Santa Cruz)

Abstract

This paper addresses the question of whether goods or asset market frictions are necessary to explain the failure of consumption risk sharing across countries. I present a multi-country DSGE model with Armington specialization. There are iceberg costs of shipping goods across countries. In asset markets, contracts are imperfectly enforceable. Both frictions separately limit the extent to which countries can pool risk. The model suggests a test for the presence of each of the two types of friction that can be implemented using data on bilateral imports. I implement this test using a sample of developed and developing countries. I find that both trade costs and asset market imperfections are necessary in order to explain the failure of perfect consumption risk sharing. However the null hypothesis of financial autarky is rejected

Suggested Citation

  • Doireann Fitzgerald, 2006. "Trade Costs, Limited Enforcement and Risk Sharing: A Joint Test," 2006 Meeting Papers 491, Society for Economic Dynamics.
  • Handle: RePEc:red:sed006:491
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    File URL: http://repec.org/sed2006/up.21157.1139957485.pdf
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    References listed on IDEAS

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    1. Heathcote, Jonathan & Perri, Fabrizio, 2002. "Financial autarky and international business cycles," Journal of Monetary Economics, Elsevier, vol. 49(3), pages 601-627, April.
    2. Backus, David K. & Smith, Gregor W., 1993. "Consumption and real exchange rates in dynamic economies with non-traded goods," Journal of International Economics, Elsevier, vol. 35(3-4), pages 297-316, November.
    3. Ravn, Morten O. & Mazzenga, Elisabetta, 2004. "International business cycles: the quantitative role of transportation costs," Journal of International Money and Finance, Elsevier, vol. 23(4), pages 645-671, June.
    4. Lucas, Robert Jr., 1982. "Interest rates and currency prices in a two-country world," Journal of Monetary Economics, Elsevier, vol. 10(3), pages 335-359.
    5. James E. Anderson & Eric van Wincoop, 2003. "Gravity with Gravitas: A Solution to the Border Puzzle," American Economic Review, American Economic Association, vol. 93(1), pages 170-192, March.
    6. Cole, Harold L. & Obstfeld, Maurice, 1991. "Commodity trade and international risk sharing : How much do financial markets matter?," Journal of Monetary Economics, Elsevier, vol. 28(1), pages 3-24, August.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    risk sharing; trade costs; asset market frictions;

    JEL classification:

    • F15 - International Economics - - Trade - - - Economic Integration
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration

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