National and Regional Patterns of Convergence and Divergence
Edited by John Adams and Francesco Pigliaru
Chapter 15: An assessment of regional risk sharing in Italy and the United Kingdom
Page 417 15. An assessment of regional risk sharing in Italy and the United Kingdom Luca Dedola, Stefano Usai and Marco Vannini 15.1 INTRODUCTION* The basic idea of risk sharing is the crosssectional counterpart of the permanent income hypothesis (Cochrane, 1991). Economic agents (and governments) pursue the insurance of consumption expenditures against income fluctuations due to shocks of different persistence. Within a competitive equilibrium, full consumption smoothing can be achieved when financial markets are complete, but it can also obtain with incomplete financial markets, even without institutions implementing optimal policies, under special assumptions concerning either the working of the security markets or the homogeneity of agents. The main theoretical implication of perfect risk sharing is that individual consumption should not vary in response to idiosyncratic income shocks. At the aggregate level, for example regions within a country or nations if one takes an international perspective, under certain assumptions Paretoefficient risk sharing implies that changes in consumption across regions (nations) are perfectly correlated. The most recent empirical literature on risk sharing (Asdrubali et al., 1996; Atkeson and Bayoumi, 1993; Canova and Ravn, 1996; Obstfeld, 1989, 1994; Townsend, 1995; van Wincoop, 1995) has focused mainly on two issues, namely the degree of risk sharing achieved internationally (or within states or villages) and the decomposition of the observed amount of income and consumption smoothing into various channels. The general area of risk sharing and consumption smoothing has received a great deal of attention for a number of reasons. It has been...
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