Risk-Taking, Global Diversification, and Growth

TLDR

The presence of safe low‑yield and risky high‑yield capital shows that growth depends on an ever‑increasing array of specialized, inherently risky production inputs. This paper develops a continuous‑time stochastic model showing that international risk‑sharing can yield substantial welfare gains through its effect on expected consumption growth. The mechanism linking global diversification to growth is a world portfolio shift from safe low‑yield capital to riskier high‑yield capital. Calibration exercises using consumption and stock‑market data imply that most countries reap large steady‑state welfare gains from global financial integration. Copyright 1994 by American Economic Association.

Abstract

This paper develops a continuous-time stochastic model in which international risk-sharing can yield substantial welfare gains through its effect on expected consumption growth. The mechanism linking global diversification to growth is an attendant world portfolio shift from safe low-yield capital to riskier high-yield capital. The presence of these two types of capital captures the idea that growth depends on the availability of an ever-increasing array of specialized, hence inherently risky, production inputs. Calibration exercises using consumption and stock-market data imply that most countries reap large steady-state welfare gains from global financial integration. Copyright 1994 by American Economic Association.