Risk sharing within the United States: What do financial markets and fiscal federalism accomplish?

We measure income uncertainty at the level of U.S. states, and the extent t o which it has been reduced through risksharing, using a method recently de veloped by Athanasoulis and van Wincoop (2000). Risk is measured as the sta ndard deviation of state-specific income growth uncertainty, measured by us ing the error term of a regression of income growth on variables in the inf ormation set. Risk sharing is measured by the extent to which this standard deviation has been reduced through financial markets and federal fiscal po licy. The advantage of this measure over the existing risk sharing literatu re is that the interpretation does not depend on many auxiliary assumptions . Our findings on the extent of risk sharing are insensitive to the only as sumption we need to make, the variables that are in the information set. We find that the standard deviation of state-specific income growth uncertain ty is reduced by less than half through financial markets and federal fisca l policy. We show that the extent of risk sharing would be much higher if a gents held better diversified portfolios across the states.