WELFARE GAINS FROM INTERNATIONAL RISKSHARING

This paper uses consumption data to compute yet unexploited welfare gains that can be achieved through risksharing among twenty OECD countries. There is both aggregate national consumption risk and nondiversifiable individual-specific risk. Countries engage in an optimal risksharing arrangement to pool risk associated with the aggregate consumption endowment streams. Welfare gains are associated with reduced consumption variability and with the international pricing of the consumption streams of individual countries. The paper considers the standard VNM time-additive preferences, as well as nonexpected utility and habit formation preferences. Large unexploited gains are found under all sets of preferences, leading to an 'international risksharing puzzle'.