The Globalization Risk Premium

Abstract

In this paper, we investigate how globalization is reflected in asset prices. We use shipping costs to measure firms' exposure to globalization. Firms in low shipping cost industries carry a 7% risk premium, suggesting that their cash flows covary negatively with investors' marginal utility. We find that the premium emanates from the risk of displacement of least efficient firms triggered by import competition. These findings suggest that foreign productivity shocks are associated with times when consumption is dear for investors. We discuss conditions under which a standard model of trade with asset prices can rationalize this puzzle.RECENT DECADES HAVE BEEN CHARACTERIZED by a high degree of trade integration. This era of globalization 1 is generally seen in a positive light, as it has been associated with more product variety at lower prices, cheaper intermediate goods, and greater access for U.S. firms to foreign markets. 2 Yet globalization also makes domestic economies more sensitive to foreign shocks. A salient * Jean-Noël Barrot is with HEC Paris and CEPR. Erik Loualiche is with the University of Minnesota, Carlson School of Management. Julien Sauvagnat is with Bocconi University and CEPR. For helpful comments, the authors thank Stefan Nagel (the Editor); Nick Bloom; Maria Cecilia Bustamante (discussant); Bernard Dumas (discussant); Nicola Gennaioli; Matthieu Gomez; Pierre-Olivier Gourinchas; Tarek Hassan (discussant); Christian Julliard; Matteo Maggiori (discussant); Jonathan Parker; Carolin Pflueger; Thomas Philippon; Nick Roussanov (discussant); Chris Telmer (discussant); Adrien Verdelhan; Michael Weber (discussant); anonymous referees; and seminar participants at MIT Sloan, SED annual meetings 1 σ J −1 . 24 We show formally in Internet Appendix Section I.A that the consumption index is C J = ( J c J (ϕ) σ J −1 σ J dϕ) σ J σ J −1 and the price index is P J = ( J p J (ϕ) 1−σ J dϕ) 1 1−σ J .We show that average profits of firms' domestic operations are π D,J (φ D,J ) and average profits for exporting operations are π X,J (φ X,J ). We define the fraction of firms that decide to export as ζ J = Pr{ϕ > ϕ X,J }. Finally, we express the profits of domestic firms from all their operations asEquilibrium: The aggregate budget constraint can be expressed in terms of the final composite consumption good, C, the aggregate price index, P, and the revenues of firms flowing back to households, , such that in each country we have PC ≤ L + .Under financial autarky, as is the case in Ghironi and Melitz (2005), households only receive the proceeds of domestic firms' operations, such that AUT = J J . Under perfect risk-sharing, households receive a share of world industry profits relative to their capital endowments, RS = J M J M J +M J

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