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Limited asset market participation and the consumption-real exchange rate anomaly

  • Robert Kollmann

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 Federal Reserve Bank of Dallas in its series Globalization and Monetary Policy Institute Working Paper with number 41.

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Date of creation: 2010
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Handle: RePEc:fip:feddgw:41
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