RISK-TAKING, GLOBAL DIVERSIFICATION, AND GROWTH

This paper develops a continuous-time stochastic model in which intern ational risk-sharing can yield substantial welfare gains through its e ffect on expected consumption growth. The mechanism linking global div ersification to growth is an attendant world portfolio shift from safe low-yield capital to riskier high-yield capital. The presence of thes e two types of capital captures the idea that growth depends on the av ailability of an ever-increasing array of specialized, hence inherentl y risky, production inputs. Calibration exercises using consumption an d stock-market data imply that most countries reap large steady-state welfare gains from global financial integration.