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International risk-sharing and the transmission of productivity shocks

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  • Giancarlo Corsetti
  • Luca Dedola
  • Sylvain Leduc

Abstract

A central puzzle in international finance is that real exchange rates are volatile and, in stark contradiction to efficient risk-sharing, negatively correlated with relative consumptions across countries. This paper shows that a model with incomplete markets and a low price elasticity of imports can account for these properties of real exchange rates. The low price elasticity stems from introducing distribution services, which drive a wedge between producer and consumer prices and lowers the impact of terms-of-trade changes on optimal agents' decisions. In the authors' model, two very different patterns of the international transmission of productivity shocks generate the observed degree of risk-sharing: one associated with an improvement, the other with a worsening of the country's terms of trade and real exchange rate. The authors provide VAR evidence on the effect of technology shocks to U.S. manufacturing, identified through long-run restrictions, in support of the first transmission pattern. These findings are at odds with the presumption that terms-of-trade movements foster international risk-pooling.

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Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 03-19.

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Date of creation: 2003
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Handle: RePEc:fip:fedpwp:03-19

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Keywords: Foreign exchange rates ; Risk ; Technology;

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