IDEAS home Printed from
MyIDEAS: Login to save this article or follow this journal

Limited participation in international business cycle models: A formal evaluation

  • Gao, Xiaodan
  • Hnatkovska, Viktoria
  • Marmer, Vadim

In this paper, we argue that limited asset market participation (LAMP) plays an important role in explaining international business cycles. We show that when LAMP is introduced into an otherwise standard model of international business cycles, the performance of the model improves significantly, especially in matching cross-country correlations. To perform formal evaluation of the models we develop a novel statistical procedure that adapts the statistical framework of Vuong (1989) to DSGE models. Using this methodology, we show that the improvements brought out by LAMP are statistically significant, leading a model with LAMP to outperform a representative agent model. Furthermore, when LAMP is introduced, a model with complete markets is found to do as well as a model with no trade in financial assets – a well-known favorite in the literature. Our results remain robust to the inclusion of investment specific technology shocks.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL:
Download Restriction: Full text for ScienceDirect subscribers only

As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.

Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 39 (2014)
Issue (Month): C ()
Pages: 255-272

in new window

Handle: RePEc:eee:dyncon:v:39:y:2014:i:c:p:255-272
Contact details of provider: Web page:

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Hnatkovska, Viktoria & Marmer, Vadim & Tang, Yao, 2012. "Comparison of misspecified calibrated models: The minimum distance approach," Journal of Econometrics, Elsevier, vol. 169(1), pages 131-138.
  2. Mankiw, N. Gregory & Zeldes, Stephen P., 1991. "The consumption of stockholders and nonstockholders," Journal of Financial Economics, Elsevier, vol. 29(1), pages 97-112, March.
  3. Backus, David K. & Smith, Gregor W., 1993. "Consumption and real exchange rates in dynamic economies with non-traded goods," Journal of International Economics, Elsevier, vol. 35(3-4), pages 297-316, November.
  4. Sumit Agarwal & Chunlin Liu & Nicholas S. Souleles, 2007. "The reaction of consumer spending and debt to tax rebates – evidence from consumer credit data," Working Paper Series WP-07-10, Federal Reserve Bank of Chicago.
  5. David S. Johnson & Jonathan A. Parker & Nicholas S. Souleles, 2004. "Household Expenditure and the Income Tax Rebates of 2001," NBER Working Papers 10784, National Bureau of Economic Research, Inc.
  6. Frank Schorfheide, 2000. "Loss function-based evaluation of DSGE models," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 15(6), pages 645-670.
  7. Heathcote, Jonathan & Perri, Fabrizio, 2002. "Financial autarky and international business cycles," Journal of Monetary Economics, Elsevier, vol. 49(3), pages 601-627, April.
  8. Shea, John, 1995. "Myopia, Liquidity Constraints, and Aggregate Consumption: A Simple Test," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(3), pages 798-805, August.
  9. Corsetti, Giancarlo & Dedola, Luca & Leduc, Sylvain, 2004. "International risk-sharing and the transmission of productivity shocks," Working Paper Series 0308, European Central Bank.
  10. Robert Kollmann, 2010. "Limited asset market participation and the consumption-real exchange rate anomaly," Globalization and Monetary Policy Institute Working Paper 41, Federal Reserve Bank of Dallas.
  11. Fernando Alvarez & Andrew Atkeson & Patrick J. Kehoe, 2000. "Money, interest rates, and exchange rates with endogenously segmented markets," Staff Report 278, Federal Reserve Bank of Minneapolis.
  12. Greenwood, J. & Hercowitz, Z. & Krusell, P., 1998. "The Role of Investment-Specific Technological Change in the Business Cycle," RCER Working Papers 449, University of Rochester - Center for Economic Research (RCER).
  13. repec:fth:harver:1435 is not listed on IDEAS
  14. Charles Engel & Akito Matsumoto, 2009. "The International Diversification Puzzle When Goods Prices Are Sticky: It's Really about Exchange-Rate Hedging, Not Equity Portfolios," American Economic Journal: Macroeconomics, American Economic Association, vol. 1(2), pages 155-88, July.
  15. Marianne Baxter & Mario J. Crucini, 1992. "Business cycles and the asset structure of foreign trade," Discussion Paper / Institute for Empirical Macroeconomics 59, Federal Reserve Bank of Minneapolis.
  16. Raffo, Andrea, 2010. "Technology Shocks: Novel Implications for International Business Cycles," CEPR Discussion Papers 7980, C.E.P.R. Discussion Papers.
  17. Alastair R. Hall & Atsushi Inoue, 2005. "The Large Sample Behaviour of the Generalized Method of Moments Estimator in Misspecified Models," Econometrics 0505002, EconWPA.
  18. van Wincoop, Eric, 1996. " A Multi-country Real Business Cycle Model with Heterogeneous Agents," Scandinavian Journal of Economics, Wiley Blackwell, vol. 98(2), pages 233-51, June.
  19. V.V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 1998. "Can sticky price models generate volatile and persistent real exchange rates?," Staff Report 223, Federal Reserve Bank of Minneapolis.
  20. Bilbiie, Florin O., 2008. "Limited asset markets participation, monetary policy and (inverted) aggregate demand logic," Journal of Economic Theory, Elsevier, vol. 140(1), pages 162-196, May.
  21. Backus, David K & Kehoe, Patrick J & Kydland, Finn E, 1994. "Dynamics of the Trade Balance and the Terms of Trade: The J-Curve?," American Economic Review, American Economic Association, vol. 84(1), pages 84-103, March.
  22. Nicholas S. Souleles, 1999. "The Response of Household Consumption to Income Tax Refunds," American Economic Review, American Economic Association, vol. 89(4), pages 947-958, September.
  23. Raymond Kan & Cesare Robotti, 2007. "Model comparison using the Hansen-Jagannathan distance," FRB Atlanta Working Paper No. 2007-04, Federal Reserve Bank of Atlanta.
  24. YiLi Chien & Harold Cole & Hanno Lustig, 2012. "Is the Volatility of the Market Price of Risk Due to Intermittent Portfolio Rebalancing?," American Economic Review, American Economic Association, vol. 102(6), pages 2859-96, October.
  25. International Monetary Fund, 2010. "Investment: Specific Technology Shocks and International Business Cycles: An Empirical Assessment," IMF Working Papers 10/207, International Monetary Fund.
  26. Hnatkovska, Viktoria & Marmer, Vadim & Tang, Yao, 2009. "Supplement to "Comparison of Misspecified Calibrated Models"," working papers vadim_marmer-2009-58, Vancouver School of Economics, revised 03 Feb 2011.
  27. Kollmann, Robert, 2006. "International Portfolio Equilibrium and the Current Account," CEPR Discussion Papers 5512, C.E.P.R. Discussion Papers.
  28. Galí, Jordi & López-Salido, J David & Vallés Liberal, Javier, 2005. "Understanding the Effects of Government Spending on Consumption," CEPR Discussion Papers 5212, C.E.P.R. Discussion Papers.
  29. Andrews, Donald W K, 1991. "Heteroskedasticity and Autocorrelation Consistent Covariance Matrix Estimation," Econometrica, Econometric Society, vol. 59(3), pages 817-58, May.
  30. Kollmann, Robert, 1996. "Incomplete asset markets and the cross-country consumption correlation puzzle," Journal of Economic Dynamics and Control, Elsevier, vol. 20(5), pages 945-961, May.
  31. Marianne Baxter, 1995. "International Trade and Business Cycles," NBER Working Papers 5025, National Bureau of Economic Research, Inc.
  32. Baxter, Marianne, 1995. "International trade and business cycles," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 35, pages 1801-1864 Elsevier.
  33. YiLi Chien & Harold Cole & Hanno Lustig, 2007. "A Multiplier Approach to Understanding the Macro Implications of Household Finance," NBER Working Papers 13555, National Bureau of Economic Research, Inc.
  34. 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.
  35. Polkovnichenko, Valery, 2004. "Limited stock market participation and the equity premium," Finance Research Letters, Elsevier, vol. 1(1), pages 24-34, March.
  36. Chatterjee, Satyajit & Corbae, Dean, 1992. "Endogenous Market Participation and the General Equilibrium Value of Money," Journal of Political Economy, University of Chicago Press, vol. 100(3), pages 615-46, June.
  37. Arvanitis, Athanasios V & Mikkola, Anne, 1996. "Asset-Market Structure and International Trade Dynamics," American Economic Review, American Economic Association, vol. 86(2), pages 67-70, May.
  38. John Y. Campbell & N. Gregory Mankiw, 1989. "Consumption, Income and Interest Rates: Reinterpreting the Time Series Evidence," NBER Chapters, in: NBER Macroeconomics Annual 1989, Volume 4, pages 185-246 National Bureau of Economic Research, Inc.
  39. Hall, Robert E & Mishkin, Frederic S, 1982. "The Sensitivity of Consumption to Transitory Income: Estimates from Panel Data on Households," Econometrica, Econometric Society, vol. 50(2), pages 461-81, March.
  40. N. Gregory Mankiw, 2000. "The Savers-Spenders Theory of Fiscal Policy," American Economic Review, American Economic Association, vol. 90(2), pages 120-125, May.
  41. Vuong, Quang H, 1989. "Likelihood Ratio Tests for Model Selection and Non-nested Hypotheses," Econometrica, Econometric Society, vol. 57(2), pages 307-33, March.
  42. Jonathan A. Parker, 1999. "The Reaction of Household Consumption to Predictable Changes in Social Security Taxes," American Economic Review, American Economic Association, vol. 89(4), pages 959-973, September.
  43. Harold L. Cole & Maurice Obstfeld, 1989. "Commodity Trade and International Risk Sharing: How Much Do Financial Markets Matter?," NBER Working Papers 3027, National Bureau of Economic Research, Inc.
  44. Annette Vissing-Jorgensen, 2002. "Limited Asset Market Participation and the Elasticity of Intertemporal Substitution," Journal of Political Economy, University of Chicago Press, vol. 110(4), pages 825-853, August.
  45. Grossman, Sanford & Weiss, Laurence, 1983. "A Transactions-Based Model of the Monetary Transmission Mechanism," American Economic Review, American Economic Association, vol. 73(5), pages 871-80, December.
  46. Gao, Xiaodan & Hnatkovska, Viktoria & Marmer, Vadim, 2013. "Supplement to “Limited Participation in International Business Cycle Models: A Formal Evaluationâ€," working papers vadim_marmer-2013-54, Vancouver School of Economics, revised 21 Dec 2013.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:eee:dyncon:v:39:y:2014:i:c:p:255-272. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Zhang, Lei)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.