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Risk Sharing in a World Economy with Uncertainty Shocks

Listed author(s):
  • Robert Kollmann

This paper analyzes the effects of output volatility shocks and of risk appetite shocks on the dynamics of consumption, trade flows and the real exchange rate, in a two-country world with recursive preferences and complete financial markets. When the risk aversion coefficient exceeds the inverse of the intertemporal substitution elasticity, then an exogenous rise in a country’s output volatility triggers a wealth transfer to that country, in equilibrium; this raises its consumption, lowers its trade balance and appreciates its real exchange rate. The effects of risk appetite shocks resemble those of volatility shocks. In a recursive preferences-complete markets framework, volatility and risk appetite shocks account for a noticeable share of the fluctuations of net exports, net foreign assets and the real exchange rate. These shocks help to explain the high empirical volatility of the real exchange rate and the disconnect between relative consumption growth and the real exchange rate.

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File URL: https://dipot.ulb.ac.be/dspace/bitstream/2013/220899/3/2015-43-KOLLMANN-risksharing.pdf
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Paper provided by ULB -- Universite Libre de Bruxelles in its series Working Papers ECARES with number ECARES 2015-43.

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Length: 25 p.
Date of creation: Nov 2015
Publication status: Published by:
Handle: RePEc:eca:wpaper:2013/220899
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