Implicit Trade in Risk and Risk Aversion

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

Abstract

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.

• Item Type: MPRA Paper
• Language: English
• Keywords: Patterns of Trade, Gains from Trade, Risk, Risk Aversion, Exports.
• Subjects: D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D81 - Criteria for Decision-Making under Risk and Uncertainty; F - International Economics > F1 - Trade > F11 - Neoclassical Models of Trade; F - International Economics > F1 - Trade > F12 - Models of Trade with Imperfect Competition and Scale Economies ; Fragmentation; F - International Economics > F1 - Trade > F13 - Trade Policy ; International Trade Organizations; G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice ; Investment Decisions

References

Anderson, J.E., (1981), "The Heckscher-Ohlin and Travis-Vanek theorems under uncertainty," Journal of International Economics, 11, 2, 239-247.

Appelbaum, E., and U., Kohli, (1997), "Import price uncertainty and the distribution of income," Review of Economics and Statistics, 79, 4, 620-630.

Appelbaum, E. and M. Melatos, (2016), "How Can Uncertainty Affect the Choice of Trade Agreements?" Economic Record, 92,297,153-172.

Appelbaum, E. and M. Melatos, (2020), "Trade Agreements as Insurance Mechanisms," University of Sydney, Discussion Paper.

Baley, I., L. Veldkamp and M. Waugh, (2020) "Can global uncertainty promote international trade?" Journal of International Economics, 126.

Batra, R. N., (1975), "Production Uncertainty and the Heckscher-Ohlin Theorem," Review of Economic Studies, 42, 130, 259-268.

Batra, R.N. and W.R. Russell (1974), "Gains from Trade Under Uncertainty," The American Economic Review, 64, 6, 1040-1048.

Brander, J. and P. Krugman, (1983), "A `reciprocal dumping' model of international trade," Journal of International Economics, 15, 3--4, 313-321.

Cheng, L.K., (1987), "Uncertainty and economic self-sufficiency," Journal of International Economics, 23, 1--2, 167-178.

Davis, D.R., and D.E., Weinstein, (2002), "The Factor Content of Trade," in Handbook of International Trade, E. Kwan Choi and James Harrigan, eds., New York: Blackwell.

Dumas, B., (1980), "The theorems of international trade under generalized uncertainty," Journal of International Economics, 10, 4, 481-498.

Gervais, A., (2018), "Uncertainty, risk aversion and international trade," Journal of International Economics, 115, 145-158.

Handley, K., (2014), "Exporting under trade policy uncertainty: Theory and evidence," Journal of International Economics, 94, 1, 50-66.

Helpman, E., and A. Razin, (1978), "Uncertainty and International Trade in the Presence of Stock Markets," The Review of Economic Studies, 45, 2, 239-250.

Helpman, E. (1984), "The factor content of foreign trade," Economic Journal, 94, 84-94.

Hoff, K., (1994), "A reexamination of the neoclassical trade model under uncertainty," Journal of International Economics, 36, 1--2, 1-27.

Levi, H., and H.M. Markovitz, (1979), "Approximating Expected Utility by a Function of Mean and Variance," American Economic Review, 69, 3, 308-17.

Logan T. Lewis, L.T, (2014), "Exports versus multinational production under nominal uncertainty," Journal of International Economics, 94, 2, 371-386.

Limão, N., and G. Maggi, (2015), "Uncertainty and Trade Agreements," American Economic Journal: Microeconomics, 7, 4, 1-42.

Ling Feng, L., Z. Li and D.L. Swenson, (2017), "Trade policy uncertainty and exports: Evidence from China's WTO accession," Journal of International Economics, 106, 20-36.

Novi, D. and A.M. Taylor, (2020), "Trade and Uncertainty," Review of Economics and Statistics, 2020, 104, 4, 749-765.

Pulley, L.B., (1983), "Mean-Variance Approximations to Expected Logarithmic Utility," Operations Research, 31, 4, 685-696.

Ruffin, R., (1974), "International trade under uncertainty," Journal of International Economics, 4,3, 243-259.

Todd, G.P., and H.M., Markowitz, (2000), Mean-Variance Analysis in Portfolio Choice and Capital Markets, Wiley.

Turnovsky, S. J. (1974), "Technological and Price Uncertainty in a Ricardian Model of International Trade," Review of Economic Studies, 40, 126, 201-217.

Vanek, J., (1968), "The factor proportions theory: The N-factor case," Kyklos, 21, 749-756.