The Role of Multinational Production in a Risky Environment

This paper explores the aggregate consequences of Foreign Direct Investment (FDI) on the opportunities for risk diversification available to consumers. The crucial difference between FDI and other international financial flows is that the former involves technology flows across countries. We present a model where firm-embedded productivity can be transferred costly across countries through the activity of multinational firms. We find that risk patterns affect multinationals ’ location decisions and, in turn, these decisions change the scope for international risk diversification even in a world with complete financial markets. A calibration exercise for OECD countries suggests that, consistent with the model, large countries tend to be net exporters of technologies. However, as shocks are strongly correlated across country, technology transfers embedded in MP flows do not substantially reduce the consumption risk premium relative to a world with no MP