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Implicit Trade in Risk and Risk Aversion

Appelbaum, Elie (2021): Implicit Trade in Risk and Risk Aversion.

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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 a net exporter of the product - hence importer of low risk. We also show that risk and risk aversion differences, and the presence of market correlation, 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 show that world gains from trade are always strictly positive, and in general, are likely to decrease with risk and correlation. Comparing gains from trade with and without uncertainty, we find that, sometimes, both world and country gains may be higher with uncertainty than without it. Finally, to get a sense of the importance of risk, risk aversion and correlation, we calculate local measures of world gains from trade elasticities. We find that world gains from trade are most responsive to changes in market correlation, highlighting the importance of diversification.

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