No. 1351 - Revisiting the case for a fiscal union: the federal fiscal channel of downside-risk sharing in the United States

Differentiating between standard risk measures and downside risk has a longstanding tradition in finance. Interestingly, this fundamental distinction has been neglected in the literature on macroeconomic-risk sharing. We translate downside-risk metrics appropriate for stock returns into ones that can be used in our macro-forecasting setting, and propose a new methodology to estimate channels of downside-risk sharing.

Our work suggests that both interstate risk sharing and downside-risk sharing in the US achieved through the federal budget is considerably higher than was previously thought. We also show that the great importance long attributed to the capital market channel is instead entirely driven by the neglect of the effect of capital depreciation.