- Economics
- Answering Challenges to Advanced Economies
We develop a tractable quantitative model of international trade in which agents make bilateral investments in resilience under general equilibrium uncertainty. Under both complete and incomplete financial markets, we show that these bilateral investments solve a portfolio problem of choosing trade partners. Countries’ risk profiles become determinants of trade flows, income and welfare, whose first moments are affected by the second moments of productivity and trade costs. Changes in global economic uncertainty have heterogeneous effects across countries, depending on how they affect real hedging opportunities. The opening of trade can raise or reduce income volatility, but is revealed-preferred to autarky.
