Sharing asymmetric tail risk: smoothing, asset pricing and terms of trade

BIS Working Papers  |  No 958  | 
10 August 2021
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 |  59 pages



International sharing of aggregate risk improves social welfare by allowing a smooth adjustment to shocks. The case for cross-border insurance remains strong even when crises are global in nature. Countries have largely different exposure to global crises - the Great Financial Crisis in 2008 and more recently the Covid-19 pandemic have largely asymmetric effects across borders.


We provide a new angle on the gains from sharing output volatility and tail risk, ie the risk of a deep downturn. We show that riskier countries primarily gain in terms of smoothing; safer countries primarily gain by the macroeconomic analogue of "selling insurance". Intuitively, safer countries achieve a higher average level of consumption through higher prices of their assets and improved terms of trade. Efficient risk-sharing thus entails implicit transfers of wealth from riskier to safer countries. 


We quantify the size and sources of the relative gains from risk-sharing for 156 countries. Our model predicts significant relative gains for both risky and safe countries. Tail risk enhances the relative gains for the latter. Relative to a safer country, the gain of a riskier country in the 95th percentile of the gains' distribution amounts to about 10% of global welfare gains.

These results have policy implications. First, they clarify how safer countries benefit from efficient financial integration and risk-sharing with countries displaying pronounced volatility and more exposed to crises and tail events (disasters). Second, they underscore the need for comprehensive indicators of aggregate insurance, beyond the reliance on consumption growth volatility and cross-border correlation.

Our paper warns about the potential welfare losses from financial protectionism and isolation. Identifying and correcting market imperfections that could reduce the benefits of financial integration should remain a necessary precondition for reaping the full benefits of international risk-sharing.


Crises and tail events have asymmetric effects across borders, raising the value of arrangements improving insurance of macroeconomic risk. Using a two-country DSGE model, we provide an analytical and quantitative analysis of the channels through which countries gain from sharing (tail) risk. Riskier countries gain in smoother consumption but lose in relative wealth and average consumption. Safer countries benefit from higher wealth and better average terms of trade. Calibrated using the empirical distribution of moments of GDP-growth across countries, the model suggests significant quantitative effects. We offer an algorithm for the correct solution of the equilibrium using DSGE models under complete markets, at higher order of approximation.

JEL classification: F15, F41, G15

Keywords: international risk sharing, asymmetry, fat tails, welfare