We study the causes and the consequences of limited risk sharing in two areas macroeconomics: the transmission of international business cycles and the welfare effect of taxes. The first two chapters focus on international business cycles, since earlier work has shown that models with perfect international risk sharing are not able to reproduce the international correlations of important macroeconomic aggregates. In the first chapter, Financial Autarky and International Business Cycles, we present a series of models of international business cycles in which the menu of internationally traded assets is exogenously restricted. We show that the allocations arising when international markets are incomplete can be significantly different form those arising under complete markets. We also show that only a model with an extreme form of incompleteness (financial, autarky) can generate volatility in the terms of trade similar to the one observed in the data and, at the same time, account for observed cross-country comovements of output, consumption, investment and employment. In the second chapter, International Business Cycles with Endogenous Incomplete Markets, we allow a full set of Arrow securities to be traded internationally, but we assume that international contracts are not perfectly enforceable so that a country can renege on his outstanding debts and suffer the associated penalties. We endogenously derive the pattern of international borrowing and lending and show that it will be constrained respect to a situation in which contracts are perfectly enforceable. We also find that allocations arising with limited enforcement are different from those arising when there are exogenously missing markets, and that the limited enforcement model can go a long way in explaining international comovements. In the last chapter, Risk Sharing: Redistributive Taxes or Private Insurance Markets, we explore the welfare effects of fiscal policy (abstracting from distortions) under different assumptions on the causes of limited insurance. We show that if limited insurance is caused by imperfect enforcement of private contracts, then a change to a more redistributive tax system might lead to less risk sharing among individuals and, hence, to lower ex-ante welfare. On the other hand if limited insurance is caused by exogenously missing markets then a change to a more progressive tax system is always welfare improving. This is an example of why studying the causes of limited risk sharing is important.
