Decentralized International Risk Sharing and Governmental Moral Hazard

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This paper studies the issue of moral hazard in the presence of decentralized international risk sharing.In the model presented, risk sharing is achieved through macro markets (markets in which claims to the GDP of a country can be traded).Moral hazard arises for the following reason: if foreigners hold claims to domestic GDP due to risk sharing motives, the country will not receive the full benefit from its production anymore.This can motivate for example a tax on investment (which reduces production) or simply result in reduced governmental effort to increase productivity.We show in a two-country general equilibrium framework that the moral hazard problem does not lead to a reduction in the risk sharing (households hold half of world output).This results ultimately in a 100% tax on investment and creates a huge distortion.We conclude that unregulated macro markets pose a serious threat to world welfare.The analysis also raises concern about the desirability of decentralized risk sharing in general, in particular risk sharing through international trade of equity.
Original languageEnglish
Publication statusPublished - 2000
Externally publishedYes

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Pagination: 37


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