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Volatility and the Gains from Trade

Author

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  • Treb Allen
  • David Atkin
Abstract
Trade liberalization changes the volatility of returns by reducing the negative correlation between local prices and productivity shocks. In this paper, we explore these second moment effects of trade. Using forty years of agricultural micro-data from India, we show that falling trade costs due to expansions of the Indian highway network reduced the responsiveness of local prices to local rainfall but increased the responsiveness of local prices to prices elsewhere. In response, farmers shifted their production toward crops with less volatile yields, especially so for those with poor access to risk mitigating technologies such as banks. We then characterize how volatility affects farmer's crop allocation using a portfolio choice framework where returns are determined in general equilibrium by a many-location, many-good Ricardian trade model with flexible trade costs. Finally, we structurally estimate the model—recovering farmers' risk-return preferences from the gradient of the mean-variance frontier at their observed crop choices—to quantify the second moment effects of trade. We find that first moment gains from specialization dominate second moment effects on average and that improvements in risk-mitigating technologies would encourage farmers to take advantage of higher-risk higher-return allocations, with the strength of these effects hinging on whether the riskiest crops are also the comparative advantage ones.

Suggested Citation

  • Treb Allen & David Atkin, 2016. "Volatility and the Gains from Trade," NBER Working Papers 22276, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:22276
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    References listed on IDEAS

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    JEL classification:

    • F1 - International Economics - - Trade
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • O13 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Agriculture; Natural Resources; Environment; Other Primary Products
    • O18 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Urban, Rural, Regional, and Transportation Analysis; Housing; Infrastructure

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