Consumption smoothing across states and time: International insurance versus foreign loans

When countries, and macroeconomic models, open up to international capital markets, the welfare gains available through completion of financial markets for contingencies potentially are much greater than those available from gaining access to non-contingent international borrowing alone. This paper goes beyond underscoring this well-known possibility numerically by showing how changes from shadow to market prices enable utility gains as first international borrowing and then insurance capabilities are introduced. However, the victory of Arrow-Debreu securities is not total when insurance payments themselves are at risk because riskless assets placed in escrow then may enhance insurability.