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Asset Prices and Risk Sharing. The Valuation Effects of Capital Market Integration

Author

Listed:
  • Giancarlo Corsetti

    (University of Cambridge)

  • Anna Lipinska

    (Federal Reserve Board)

  • Giovanni Lombardo

    (Bank for International Settlements)

Abstract

Gains from trade in assets can always be decomposed into a consumption smoothing (volatility) and valuation (average) term. The latter follows from the changes in the present discounted value of domestic output when this is re-valued at the new equilibrium (state contingent) prices. We show that even when theory restricts the overall gains to be positive, either the smoothing or the valuation term may be negative, per effect of asymmetries in economic size and risk. We also point out that omitting the specification of the budget constraint in complete market models, a widespread practice in the quantitative literature, leads to substantial bias in welfare assessment. We provide a method to redress this problem in an accurate and efficient way.

Suggested Citation

  • Giancarlo Corsetti & Anna Lipinska & Giovanni Lombardo, 2019. "Asset Prices and Risk Sharing. The Valuation Effects of Capital Market Integration," 2019 Meeting Papers 679, Society for Economic Dynamics.
    • Handle: RePEc:red:sed019:679
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    References listed on IDEAS

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    Cited by:

    1. Kuester, Keith & Corsetti, Giancarlo & Müller, Gernot & Schmidt, Sebastian, 2021. "The Exchange Rate Insulation Puzzle," CEPR Discussion Papers 15689, C.E.P.R. Discussion Papers.

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