INTERNATIONAL RISK-SHARING AND NONTRADED GOODS

The high correlation between savings and investment, the low cross-country correlation between consumption growth rates and the home bias in investment portfolios have been interpreted as evidence that international financial markets are insufficient for complete risk-sharing. This paper demonstrates that these facts are consistent with complete financial markets when agents face stochastic fluctuations in the output of non-traded goods. Consumer preferences over traded and non-traded goods and over the intertemporal allocation of consumption may skew portfolios toward claims on domestic output. A dynamic version of the model calibrated to estimates of the parameters describing preferences and technology replicates the main features of savings, investment, consumption and output.