The Impact of Firm Heterogeneity on International Risk-Sharing

This study is significant as it explores whether firm heterogeneity with non-tradable goods and financial integration contributes to better international risk-sharing. We construct a dynamic stochastic general equilibrium framework to examine the impact of wealth effects on international risk-sharing. Our findings reveal that the wealth effect is another crucial factor for the limited risk-sharing observed in response to a positive idiosyncratic shock affecting heterogeneous firms, despite the non-tradable goods sector and incomplete financial market being the primary reasons for limited risk-sharing between the two countries. We further investigate the implication of wealth effects for international risk-sharing and demonstrate that financial frictions across borders impede the spillover of wealth effects from the home country to the foreign country, resulting in decreased risk-sharing (the consumption co-movement across countries is low). The impact of wealth effects will be weakened if domestic households prefer to consume more non-tradable or home-produced goods, leading to lower risk-sharing.