TY  - JOUR
AU  - Davis,Steven J.
AU  - Nalewaik,Jeremy
AU  - Willen,Paul
TI  - On the Gains to International Trade in Risky Financial Assets
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 7796
PY  - 2000
Y2  - July 2000
UR  - http://www.nber.org/papers/w7796
L1  - http://www.nber.org/papers/w7796.pdf
N1  - Author contact info:
Steven J. Davis
Booth School of Business
The University of Chicago
5807 South Woodlawn Avenue
Chicago, IL 60637
Tel: 773/702-7312
Fax: 773/834-0733
E-Mail: Steven.Davis@ChicagoBooth.edu

Jeremy Nalewaik
Federal Reserve Board
20th and C, NW
Washington, DC 20551
E-Mail: jeremy.j.nalewaik@frb.gov

Paul S. Willen
Federal Reserve Bank of Boston
600 Atlantic Avenue
Boston, MA  02210-2204
Tel: 617/973-3149
Fax: 617/973-2123
E-Mail: willen968@gmail.com
AB  - This paper develops and implements a framework for quantifying the gains to international trade in risky financial assets.  The framework can handle may agents, many assets, incomplete markets and limited participation in asset markets. It delivers closed-form analytic solutions for consumption, portfolio allocations, asset prices and the gains to trade. We find enormous gains to trade when asset returns are calibrated to observed risk premia and all agents participate in asset markets.  The gains-to-trade puzzle is closely related to, but distinct from, the equity premium puzzle.  High risk aversion merely alters the form of the gains-to-trade puzzle, but limited participation in asset markets goes a long way towards addressing both puzzles. We also identify three reasons for limited international risk sharing.  First, the requirement that asset markets span the space of national output shocks fails in a serious way.  Second, for many countries the cost of using financial assets to hedge national output shocks greatly exceeds the benefits.  Third, limited asset market participation reduces the feasible gains from international risk sharing.
ER  -