International good market segmentation and financial innovation

While international capital flows are now well liberalized, markets for goods remain segmented. To investigate how financial innovation may relieve the effects of this segmentation on risk sharing, we examine a series of two-country economies with internationally segmented good markets, distinguished by the available financial securities. Sufficient conditions for efficiency include complete international financial markets together with liberalized international financial flows. Under these conditions, heterogeneous agents from the same country may use securities as a substitute for the international shipment of goods. This allows them to partially circumvent the segmentation, allowing for efficient risk sharing. (C) 2006 Elsevier B.V. All rights reserved.