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Stochastic discount factor approach to international risk-sharing: evidence from fixed exchange rate episodes

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  • M. Hadzi-Vaskov
  • C.J.M. Kool

Abstract

This paper presents evidence of the stochastic discount factor approach to international risk-sharing applied to fixed exchange rate regimes. We calculate risk-sharing indices for two episodes of fixed or very rigid exchange rates: the Eurozone before and after the introduction of the Euro, and several emerging economies in the period 1993-2005. This approach suggests almost perfect bilateral risk-sharing among all countries from the Eurozone. Moreover, it implies that emerging markets with fixed/rigid nominal exchange rates against the US dollar in the period achieved almost perfect risk-sharing with the US. We conclude that risk-sharing measures crucially depend on the behavior of the nominal exchange rate, implying almost perfect risk-sharing among countries with fixed/rigid nominal exchange rates. Second, a counterintuitive ranking of the risksharing levels under different nominal exchange rate regimes suggests a limited use of this approach for cross-country risk-sharing comparisons. Real exchange rates might be very smooth, but risk-sharing across countries is not necessarily perfect.

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Bibliographic Info

Paper provided by Utrecht School of Economics in its series Working Papers with number 07-33.

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Length: 62 pages
Date of creation: 2008
Date of revision:
Handle: RePEc:use:tkiwps:0733

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Keywords: International Risk-Sharing; Stochastic Discount Factor; Fixed Exchange Rates; Exchange Rate Regimes;

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  1. David K. Backus & Patrick J. Kehoe & Finn E. Kydland, 1991. "International real business cycles," Staff Report 146, Federal Reserve Bank of Minneapolis.
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  13. Lewis, Karen K., 2000. "Why do stocks and consumption imply such different gains from international risk sharing?," Journal of International Economics, Elsevier, vol. 52(1), pages 1-35, October.
  14. Karen K. Lewis, 1999. "Trying to Explain Home Bias in Equities and Consumption," Journal of Economic Literature, American Economic Association, vol. 37(2), pages 571-608, June.
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