Risk Gravity

Luciana Juvenal, Paulo Santos Monteiro

We consider the canonical trade model with heterogeneous firms, love for variety and trade costs, and integrate it in the consumption CAPM model. This yields a structural gravity equation that includes an additional factor related to risk premia. Empirical evidence based on firm-level data confirms the importance of cross-sectional heterogeneity in risk and time-varying risk premia to shape bilateral trade flows. The structural gravity model augmented to account for fluctuations in risk premia offers a compelling explanation for trade collapses during abrupt economic downturns. (JEL: D81, E32, F10)

Keywords: risk premia, gravity equation, trade collapse.

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