World income components: Measuring and exploiting risk-sharing opportunities

A method is constructed for decomposing the variance of changes in incomes in the world into components, to indicate the most important risk-sharing opportunities among people of the world. A constant absolute risk premium (CARP) inodel, an intertemporal general-equilibrium model of the world, is presented to permit optimal contract design. For a contract designer maximizing a social welfare function, the optimal contracts maximize the equilibrium world real interest rate. Securities are defined in terms of eigenvectors of a transformed variance inatrix. Vie method is applied using Penn World Table data on the G-7 countries, 1950-1992.