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Risk Diversification and International Trade

Author

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  • Federico Esposito

    (Yale University)

Abstract
Firms face considerable uncertainty about consumers' demand. In presence of incomplete financial markets, entrepreneurs may not be able to insure against unexpected demand fluctuations. The key insight of my paper is that firms can hedge demand risk through geographical diversification. I first develop a general equilibrium trade model characterized by stochastic demand and risk-averse entrepreneurs, who exploit the imperfect correlation of demand across countries to lower the variance of their total sales. I show that: i) a firm's exporting decision does not obey a hierarchical structure as in standard models with fixed costs, because it depends on the global diversification strategy of the firm, and ii) the intensity of trade flows to a market are affected by its risk-return profile. To quantify the risk diversification benefits of international trade I calibrate the model with the Method of Moments, using Portuguese firm-level data. One of the counterfactual exercises reveals that the welfare gains from trade can be significantly higher than the gains predicted by models neglecting firm level risk. After a trade liberalization, risk-averse firms boost exports to countries offering better diversification benefits. Hence, in these markets competition among firms is stronger, lowering the price level more and raising welfare gains.

Suggested Citation

  • Federico Esposito, 2016. "Risk Diversification and International Trade," 2016 Meeting Papers 302, Society for Economic Dynamics.
    • Handle: RePEc:red:sed016:302
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    Cited by:

    1. De Sousa, José & Disdier, Anne-Célia & Gaigné, Carl, 2020. "Export decision under risk," European Economic Review, Elsevier, vol. 121(C).
    2. Heiland, Inga, 2016. "Global Risk Sharing Through Trade in Goods and Assets: Theory and Evidence," VfS Annual Conference 2016 (Augsburg): Demographic Change 145821, Verein für Socialpolitik / German Economic Association.
    3. Ashraf, Badar Nadeem & Qian, Ningyu & Shen, Yinjie (Victor), 2021. "The impact of trade and financial openness on bank loan pricing: Evidence from emerging economies," Emerging Markets Review, Elsevier, vol. 47(C).
    4. Héricourt, Jérôme & Nedoncelle, Clément, 2018. "Multi-destination firms and the impact of exchange-rate risk on trade," Journal of Comparative Economics, Elsevier, vol. 46(4), pages 1178-1193.
    5. Urška Čede & Bogdan Chiriacescu & Péter Harasztosi & Tibor Lalinsky & Jaanika Meriküll, 2018. "Export characteristics and output volatility: comparative firm-level evidence for CEE countries," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 154(2), pages 347-376, May.
    6. Héricourt, Jérôme & Nedoncelle, Clément, 2018. "Multi-destination firms and the impact of exchange-rate risk on trade," Journal of Comparative Economics, Elsevier, vol. 46(4), pages 1178-1193.
    7. Antoine Gervais, 2021. "Global sourcing under uncertainty," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 54(3), pages 1103-1135, November.

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