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International risk-sharing and the transmission of productivity shocks

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  • Corsetti, Giancarlo
  • Dedola, Luca
  • Leduc, Sylvain

Abstract

A central puzzle in international finance is that real exchange rates are volatile and, in stark contradiction to effcient risk-sharing, negatively correlated with cross-country consumption ratios. This paper shows that incomplete asset markets and a low price elasticity of tradables can account quantitatively for these properties of real exchange rates. The low price elasticity stems from distribution services, intensive in local inputs, which drive a wedge between producer and consumer prices and lower the impact of terms-of-trade changes on optimal agents' decisions. Two very different patterns of the international transmission of productivity improvements generate the observed degree of risk-sharing: one associated with a strengthening, the other with a deterioration of the terms of trade and real exchange rate. Evidence on the effect of technology shocks to U.S. manufacturing, identified through long-run restrictions, is found in support of the first transmission pattern, questioning the presumption that terms-of-trade movements foster international risk-pooling. JEL Classification: F32, F33, F41

Suggested Citation

  • Corsetti, Giancarlo & Dedola, Luca & Leduc, Sylvain, 2004. "International risk-sharing and the transmission of productivity shocks," Working Paper Series 308, European Central Bank.
  • Handle: RePEc:ecb:ecbwps:2004308
    Note: 80922
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    More about this item

    Keywords

    consumption-real exchange rate; distribution margin; incomplete asset markets;
    All these keywords.

    JEL classification:

    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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