Stochastic Discount Factor Approach to International Risk-Sharing: Evidence from Fixed Exchange Rate Episodes

This paper presents evidence of the stochastic discount factor approach to
international risk-sharing applied to fixed exchange rate regimes. We calculate
risk-sharing indices for two episodes of fixed or very rigid exchange rates: the
Eurozone before and after the introduction of the Euro, and several emerging
economies in the period 1993-2005. This approach suggests almost perfect
bilateral risk-sharing among all countries from the Eurozone. Moreover, it implies
that emerging markets with fixed/rigid nominal exchange rates against the US
dollar in the period achieved almost perfect risk-sharing with the US. We conclude
that risk-sharing measures crucially depend on the behavior of the nominal
exchange rate, implying almost perfect risk-sharing among countries with
fixed/rigid nominal exchange rates. Second, a counterintuitive ranking of the risk-sharing
levels under different nominal exchange rate regimes suggests a limited
use of this approach for cross-country risk-sharing comparisons. Real exchange
rates might be very smooth, but risk-sharing across countries is not necessarily
perfect.