Risk Sharing in International Economies and Market Incompleteness

We develop an incomplete markets framework to show that international risk sharing can be low, particularly among countries with large interest-rate differentials. Furthermore, risk sharing computed from asset returns can be consistent with that computed from consumption. The key difference from Brandt, Cochrane, and Santa-Clara (2006) is that exchange rate growth need not equal the ratio of stochastic discount factors (SDF), and we develop a restriction that precludes “good deals” in international economies with incomplete markets. We compute the lowest risk sharing consistent with SDFs that (i) are nonnegative, (ii) correctly price returns, and (iii) disallow “good deals.”