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Limited Asset Market Participation and the Consumption-Real Exchange Rate Anomaly

  • Kollmann, Robert

Under efficient consumption risk sharing, as assumed in standard international business cycle models, a country’s aggregate consumption rises relative to foreign consumption, when the country’s real exchange rate depreciates. Yet, empirically, relative consumption and the real exchange rate are essentially uncorrelated. I show that this ‘consumption-real exchange rate anomaly’ can be explained by a simple model in which a subset of households trade in complete financial markets, while the remaining households lead hand-to-mouth (HTM) lives. HTM behavior also generates greater volatility of the real exchange rate and of net exports, which likewise brings the model closer to the data.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7452.

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Date of creation: Sep 2009
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Handle: RePEc:cpr:ceprdp:7452
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