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The international risk-sharing puzzle is at business-cycle and lower frequency

Author

Listed:
  • Giancarlo Corsetti

    (Cambridge University)

  • Luca Dedola

    (European Central Bank)

  • Francesca Viani

    () (Banco de España)

Abstract

We decompose the correlation between relative consumption and the real exchange rate into its dynamic components at different frequencies. Using multivariate spectral analysis techniques we show that, at odds with a high degree of risk-sharing, in most OECD countries the dynamic correlation tends to be quite negative, and significantly so, at frequencies lower than two years —the appropriate frequencies for assessing the performance of international business cycle models. Theoretically, we show that the dynamic correlation over different frequencies predicted by standard open-economy models is the sum of two terms: a term constant across frequencies, which can be negative when uninsurable risk is large; and a term variable across frequencies, which in bond economies is necessarily positive, reflecting the insurance that intertemporal trade provides against forecastable contingencies. Numerical analysis suggests that leading mechanisms proposed by the literature to account for the puzzle are consistent with the evidence across the spectrum.

Suggested Citation

  • Giancarlo Corsetti & Luca Dedola & Francesca Viani, 2012. "The international risk-sharing puzzle is at business-cycle and lower frequency," Working Papers 1212, Banco de España;Working Papers Homepage.
  • Handle: RePEc:bde:wpaper:1212
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    References listed on IDEAS

    as
    1. 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.
    2. Corsetti, Giancarlo & Dedola, Luca & Leduc, Sylvain, 2008. "High exchange-rate volatility and low pass-through," Journal of Monetary Economics, Elsevier, vol. 55(6), pages 1113-1128, September.
    3. Kollmann, Robert, 1995. "Consumption, real exchange rates and the structure of international asset markets," Journal of International Money and Finance, Elsevier, vol. 14(2), pages 191-211, April.
    4. Giancarlo Corsetti & Luca Dedola & Francesca Viani, 2012. "Traded and Nontraded Goods Prices, and International Risk Sharing: An Empirical Investigation," NBER International Seminar on Macroeconomics, University of Chicago Press, vol. 8(1), pages 403-466.
    5. Pietro Cova & Massimiliano Pisani & Nicoletta Batini & Alessandro Rebucci, 2008. "Productivity and Global Imbalances: The Role of Nontradable Total Factor Productivity in Advanced Economies," IMF Staff Papers, Palgrave Macmillan, vol. 55(2), pages 312-325, June.
    6. Fabio Ghironi & Marc J. Melitz, 2005. "International Trade and Macroeconomic Dynamics with Heterogeneous Firms," The Quarterly Journal of Economics, Oxford University Press, vol. 120(3), pages 865-915.
    7. Benigno, Gianluca & Thoenissen, Christoph, 2008. "Consumption and real exchange rates with incomplete markets and non-traded goods," Journal of International Money and Finance, Elsevier, vol. 27(6), pages 926-948, October.
    8. Devereux, Michael B. & Smith, Gregor W. & Yetman, James, 2012. "Consumption and real exchange rates in professional forecasts," Journal of International Economics, Elsevier, vol. 86(1), pages 33-42.
    9. Ravn, Morten O, 2001. "Consumption Dynamics and Real Exchange Rate," CEPR Discussion Papers 2940, C.E.P.R. Discussion Papers.
    10. Rabanal, Pau & Rubio-Ramírez, Juan F., 2015. "Can international macroeconomic models explain low-frequency movements of real exchange rates?," Journal of International Economics, Elsevier, vol. 96(1), pages 199-211.
    11. Christophe Croux & Mario Forni & Lucrezia Reichlin, 2001. "A Measure Of Comovement For Economic Variables: Theory And Empirics," The Review of Economics and Statistics, MIT Press, vol. 83(2), pages 232-241, May.
    12. Gabor Pula & Daniel Santabárbara, 2012. "Is china climbing up the quality ladder?," Working Papers 1209, Banco de España;Working Papers Homepage.
    13. Stockman, Alan C & Tesar, Linda L, 1995. "Tastes and Technology in a Two-Country Model of the Business Cycle: Explaining International Comovements," American Economic Review, American Economic Association, vol. 85(1), pages 168-185, March.
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    Citations

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    Cited by:

    1. Giancarlo Corsetti & Luca Dedola & Francesca Viani, 2012. "Traded and Nontraded Goods Prices, and International Risk Sharing: An Empirical Investigation," NBER International Seminar on Macroeconomics, University of Chicago Press, vol. 8(1), pages 403-466.
    2. repec:eee:joecas:v:11:y:2014:i:c:p:1-7 is not listed on IDEAS
    3. Bengui, Julien & Mendoza, Enrique G. & Quadrini, Vincenzo, 2013. "Capital mobility and international sharing of cyclical risk," Journal of Monetary Economics, Elsevier, vol. 60(1), pages 42-62.
    4. Iwata, Yasuharu, 2013. "Two fiscal policy puzzles revisited: New evidence and an explanation," Journal of International Money and Finance, Elsevier, vol. 33(C), pages 188-207.
    5. Predrag Petrović, 2016. "Backus–Smith puzzle and the European Union: It’s not just the nominal exchange rate," Zbornik radova Ekonomskog fakulteta u Rijeci/Proceedings of Rijeka Faculty of Economics, University of Rijeka, Faculty of Economics, vol. 34(2), pages 393-418.
    6. Aydan Dogan, 2014. "Euro- US Real Exchange Rate Dynamics: How Far Can We Push Equilibrium Models?," Studies in Economics 1409, School of Economics, University of Kent.
    7. Trezzi, Riccardo, 2013. "A wavelet analysis of international risk-sharing," Economics Letters, Elsevier, vol. 118(2), pages 330-333.
    8. Rabanal, Pau & Rubio-Ramírez, Juan F., 2015. "Can international macroeconomic models explain low-frequency movements of real exchange rates?," Journal of International Economics, Elsevier, vol. 96(1), pages 199-211.
    9. Donadelli, Michael & Paradiso, Antonio, 2014. "Does financial integration affect real exchange rate volatility and cross-country equity market returns correlation?," The North American Journal of Economics and Finance, Elsevier, vol. 28(C), pages 206-220.
    10. Akkoyun, H. Cagri & Arslan, Yavuz & Kanik, Birol, 2013. "Housing prices and transaction volume," Journal of Housing Economics, Elsevier, vol. 22(2), pages 119-134.
    11. Jean-François Rouillard, 2013. "International Risk Sharing and Land Dynamics," Cahiers de recherche 13-02, Departement d'Economique de l'École de gestion à l'Université de Sherbrooke.
    12. Devereux, Michael B. & Kollmann, Robert, 2012. "International Risk Sharing," MPRA Paper 70129, University Library of Munich, Germany.

    More about this item

    Keywords

    Consumption-exchange rate anomaly; incomplete markets; frequency domain analysis;

    JEL classification:

    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission

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