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International Risk Sharing and Portfolio Choice with Non-separable Preferences

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  • Küçük, Hande
  • Sutherland, Alan

Abstract

This paper aims to account for the Backus-Smith puzzle in a two-country DSGE model with endogenous portfolio choice in bonds and equities. Utility is non-separable across consumption and leisure and across time. This model is shown to imply almost zero correlation between relative consumption and the real exchange rate while generating portfolio positions that broadly match the data. Furthermore, the cross-country correlation of consumption is lower than the correlation of output, which has previously been a difficult fact to match. Non-separable preferences are found to be crucial to generating these results but financial market structure plays only a minor role.

Suggested Citation

  • Küçük, Hande & Sutherland, Alan, 2015. "International Risk Sharing and Portfolio Choice with Non-separable Preferences," CEPR Discussion Papers 10724, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:10724
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    Cited by:

    1. Kollmann, Robert, 2016. "International business cycles and risk sharing with uncertainty shocks and recursive preferences," Journal of Economic Dynamics and Control, Elsevier, vol. 72(C), pages 115-124.

    More about this item

    Keywords

    Backus-Smith puzzle; consumption-real exchange rate anomaly; incomplete markets; international risk sharing; non-separable preferences; portfolio choice;

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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