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Household Heterogeneity and Real Exchange Rates

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  • Kocherlakota, Narayana
  • Pistaferri, Luigi

Abstract

We assume that individuals can fully insure themselves against cross-country shocks, but not against individual-specific shocks. We consider two particular models of limited risk-sharing: domestically incomplete markets (DI) and private information-Pareto optimal (PIPO) risk-sharing. For each model, we derive a restriction relating the cross-sectional distributions of consumption and real exchange rates. We evaluate these restrictions using household-level consumption data from the US and the UK. We show that the PIPO restriction fits the data well when households have a coefficient of relative risk aversion of around 5. The restrictions implied by the complete risk-sharing model and the DI model fare poorly.

Suggested Citation

  • Kocherlakota, Narayana & Pistaferri, Luigi, 2007. "Household Heterogeneity and Real Exchange Rates," CEPR Discussion Papers 6192, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:6192
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    References listed on IDEAS

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    7. Narayana Kocherlakota & Luigi Pistaferri, 2009. "Asset Pricing Implications of Pareto Optimality with Private Information," Journal of Political Economy, University of Chicago Press, vol. 117(3), pages 555-590, June.
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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. Kyriacos Lambrias, 2013. "News Shocks, Real Exchange Rates and International Co-Movements," BCL working papers 83, Central Bank of Luxembourg.
    3. Hansen, Lars Peter, 2013. "Risk Pricing over Alternative Investment Horizons," Handbook of the Economics of Finance, Elsevier.
    4. Basu, Parantap & Semenov, Andrei & Wada, Kenji, 2011. "Uninsurable risk and financial market puzzles," Journal of International Money and Finance, Elsevier, vol. 30(6), pages 1055-1089, October.
    5. Simona E. Cociuba & Ananth Ramanarayanan, 2011. "International Risk Sharing with Endogenously Segmented Asset Markets," 2011 Meeting Papers 853, Society for Economic Dynamics.
    6. Lo Prete, Anna, 2013. "Sharing risk within and across countries: the role of labor market institutions," Economic Systems, Elsevier, vol. 37(3), pages 449-461.
    7. Vitor F. Luz & Carlos E. da Costa, 2010. "The Private Memory of Aggregate Shocks," 2010 Meeting Papers 368, Society for Economic Dynamics.
    8. Pierpaolo Benigno, 2007. "Portfolio Choices with Near Rational Agents: A Solution of Some International-Finance Puzzles," NBER Working Papers 13173, National Bureau of Economic Research, Inc.
    9. Heathcote, Jonathan & Perri, Fabrizio, 2014. "Assessing International Efficiency," Handbook of International Economics, Elsevier.
    10. Golosov, Mikhail & Troshkin, Maxim & Tsyvinski, Aleh & Weinzierl, Matthew, 2013. "Preference heterogeneity and optimal capital income taxation," Journal of Public Economics, Elsevier, pages 160-175.
    11. Lambrias, Kyriacos, 2016. "Real exchange rates and international co-movement: news-shocks and non-tradable goods with complete markets," Working Paper Series 1946, European Central Bank.
    12. Viktor Tsyrennikov, 2007. "Capital Flows and Moral Hazard," 2007 Meeting Papers 455, Society for Economic Dynamics.
    13. Kollmann, Robert, 2009. "Household Heterogeneity and the Real Exchange Rate: Still a Puzzle," CEPR Discussion Papers 7301, C.E.P.R. Discussion Papers.
    14. Vitor F. Luz & Carlos E. da Costa, 2011. "Separability and Memory: Micro Causes, Macro Consequences," 2011 Meeting Papers 916, Society for Economic Dynamics.
    15. Matthew Canzoneri & Robert Cumby & Behzad Diba, 2013. "Addressing International Empirical Puzzles: the Liquidity of Bonds," Open Economies Review, Springer, pages 197-215.
    16. Meghir, Costas & Pistaferri, Luigi, 2011. "Earnings, Consumption and Life Cycle Choices," Handbook of Labor Economics, Elsevier.
    17. Devereux, Michael B. & Smith, Gregor W. & Yetman, James, 2012. "Consumption and real exchange rates in professional forecasts," Journal of International Economics, Elsevier, pages 33-42.
    18. Parantap Basu & Andrei Semenovz & Kenji Wadax, 2007. " Uninsurable Risk and Financial Market Puzzles," CDMA Conference Paper Series 0701, Centre for Dynamic Macroeconomic Analysis.
    19. Narayana Kocherlakota & Luigi Pistaferri, 2008. "Household Heterogeneity and Asset Trade: Resolving the Equity Premium Puzzle in Three Countries," Levine's Bibliography 122247000000001886, UCLA Department of Economics.
    20. A. Craig Burnside & Jeremy J. Graveline, 2012. "On the Asset Market View of Exchange Rates," NBER Working Papers 18646, National Bureau of Economic Research, Inc.
    21. Kollmann, Robert, 2009. "Domestic Financial Frictions: Implications for International Risk Sharing, Real Exchange Rate Volatility and International Business Cycles," MPRA Paper 70348, University Library of Munich, Germany.

    More about this item

    Keywords

    market incompleteness; Pareto optimality; precautionary savings; real exchange rate;

    JEL classification:

    • D63 - Microeconomics - - Welfare Economics - - - Equity, Justice, Inequality, and Other Normative Criteria and Measurement
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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