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Net foreign assets and imperfect pass-through: the consumption real exchange rate anomaly

Listed author(s):
  • Jorge Selaive
  • Vicente Tuesta

An unresolved issue in international macroeconomics is the apparent lack of risk-sharing across countries, which contradicts the prediction of models based on the assumption of complete markets. We assess the importance of financial frictions in this issue by constructing an incomplete market model with stationary net foreign assets (NFA) and imperfect pass-through (IPT). In this paper, there is a cost of bond holdings that allows us to incorporate the dynamics of NFA into the risk-sharing condition. On theoretical grounds, our results suggest that the dynamics of NFA may account for the lack of risk-sharing across countries. In addition, the IPT mechanism, by closing the current account channel, does not help to explain this feature of the data. On empirical grounds, we test the risk-sharing condition derived in the paper, and we find that growth factors of consumption and real exchange rates behave in a manner that may be consistent with a significant role for the net foreign asset position.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 764.

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Date of creation: 2003
Handle: RePEc:fip:fedgif:764
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