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What Can Explain the Apparent Lack of International Consumption Risk Sharing?

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  • Karen K. Lewis
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    Abstract

    Recent research in international business cycles based upon complete markets has found that international consumption correlations are lower than predicted by the standard risk-sharing implications of these models. In this paper, I use regression tests to ask whether two different types of explanations can help explain this result. First, I consider whether non-separabilities between tradeables and non-tradeable leisure or goods can explain the puzzle. Surprisingly, non-separabilities explain only a tiny fraction of the variation in tradeables consumption across countries. Furthermore, risk-sharing in tradeables is rejected. Second, I examine the effects of capital market restrictions on aggregate consumption risk-sharing by countries. While rejections of risk-sharing are stronger for countries facing more severe capital market restrictions, risk-sharing is still rejected for the unrestricted group of countries. Therefore, risk-sharing does not appear to be resolved by either explanation alone. However, when I allow for both non-separabilities and certain market restrictions, risk-sharing among unrestricted countries is not rejected. This evidence suggests that a combination of these two effects may be necessary to explain consumption risk-sharing across countries.

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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5203.

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    Date of creation: Aug 1995
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    Publication status: published as Journal of Political Economy, April 1996, vol.104, pp.267-297.
    Handle: RePEc:nbr:nberwo:5203

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    1. Burdett, Kenneth & Wright, Randall, 1989. "Unemployment Insurance and Short-Time Compensation: The Effects on Layoffs, Hours per Worker, and Wages," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 97(6), pages 1479-96, December.
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    3. Alan C. Stockman & Linda L. Tesar, 1991. "Tastes and technology in a two-country model of the business cycle: explaining international co-movements," Working Paper 9019, Federal Reserve Bank of Cleveland.
    4. Urban J. Jermann & Marianne Baxter, 1999. "Household Production and the Excess Sensitivity of Consumption to Current Income," American Economic Review, American Economic Association, American Economic Association, vol. 89(4), pages 902-920, September.
    5. Maurice Obstfeld, 1986. "How Integrated are World Capital Markets? Some New Tests," NBER Working Papers 2075, National Bureau of Economic Research, Inc.
    6. Marianne Baxter & Mario J. Crucini, 1992. "Business cycles and the asset structure of foreign trade," Discussion Paper / Institute for Empirical Macroeconomics, Federal Reserve Bank of Minneapolis 59, Federal Reserve Bank of Minneapolis.
    7. Michael B. Devereux & Allan W. Gregory & Gregor W. Smith, 1990. "Realistic Cross-Country Consumption Correlations in a Two-Country, Equilibrium, Business Cycle Model," Working Papers, Queen's University, Department of Economics 774, Queen's University, Department of Economics.
    8. John Heaton & Deborah Lucas, 1993. "Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing," NBER Working Papers 4249, National Bureau of Economic Research, Inc.
    9. Heaton, John & Lucas, Deborah, 1995. "The importance of investor heterogeneity and financial market imperfections for the behavior of asset prices," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 42(1), pages 1-32, June.
    10. Robert E. Cumby & John Huizinga, 1990. "Testing The Autocorrelation Structure of Disturbances in Ordinary Least Squares and Instrumental Variables Regressions," NBER Technical Working Papers 0092, National Bureau of Economic Research, Inc.
    11. Fabio Canova & Morten O. Ravn, 1993. "International consumption risk sharing," Economics Working Papers, Department of Economics and Business, Universitat Pompeu Fabra 135, Department of Economics and Business, Universitat Pompeu Fabra, revised Jun 1995.
    12. Domenico Cuoco & Jaksa Cvitanic, . "Optimal Consumption Choices for a "Large" Investor," Rodney L. White Center for Financial Research Working Papers, Wharton School Rodney L. White Center for Financial Research 04-96, Wharton School Rodney L. White Center for Financial Research.
    13. Backus, David K & Kehoe, Patrick J & Kydland, Finn E, 1992. "International Real Business Cycles," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 100(4), pages 745-75, August.
    14. Mace, Barbara J, 1991. "Full Insurance in the Presence of Aggregate Uncertainty," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 99(5), pages 928-56, October.
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    16. Atkinson, Anthony B & Micklewright, John, 1991. "Unemployment Compensation and Labor Market Transitions: A Critical Review," Journal of Economic Literature, American Economic Association, American Economic Association, vol. 29(4), pages 1679-1727, December.
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    Cited by:
    1. Kraay, Aart & Ventura, Jaume, 1995. "Trade and fluctuations," Policy Research Working Paper Series 1560, The World Bank.
    2. Eijffinger, Sylvester & Wagner, Wolf, 2010. "Incentive problems and the pattern of international risk sharing," Journal of International Money and Finance, Elsevier, Elsevier, vol. 29(7), pages 1206-1225, November.

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