World Income Components: Measuring and Exploiting Risk-Sharing Opportunities
We provide a method for decomposing the variance of changes in incomes in the world into components, world income components (WICs), in such a way as to indicate the most important risk-sharing opportunities among people of the world. We develop a constant absolute risk premium model, an intertemporal general equilibrium model of the world that facilitates consideration of optimal contract design. We show that for a contract designer maximizing a social welfare function, the optimal risk-management contracts maximize the equilibrium world real interest rate. That is the contract designer achieves the risk-optimal interest rate. We show that these WIC securities are deﬁned in terms of eigenvectors of a transformed variance matrix of income changes. The method is applied with a variance matrix estimated using Penn World Table data on the G-7 countries, 1950-92.
Athanasoulis, Stefano G. and Shiller, Robert J., "World Income Components: Measuring and Exploiting Risk-Sharing Opportunities" (1999). Cowles Foundation Discussion Papers. 1488.