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International risk sharing and low cross-country consumption correlations: are they really inconsistent?

  • Michael R. Pakko

In dynamic equilibrium trade models, the common assumption that asset markets are complete implies that correlations of consumption across countries should be quite high. In contrast, measured consumption correlations tend to be rather low. While some suggest this implies that asset market incompleteness is a fundamental feature determining international trade dynamics, this paper provides an example ofa simple model economy in which complete markets can be associated with consumption correlations that are lower than output correlations. Conditions for substitution elasticities associated with this result are derived for a two-country, two-good endowment model with heterogeneous agents.

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 1994-019.

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Date of creation: 1996
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Publication status: Published in Review of International Economics, August 1997, 5(3), pp. 386-400
Handle: RePEc:fip:fedlwp:1994-019
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  1. Feeney, JoAnne & Jones, Ronald W, 1994. "Risk Aversion and International Markets: Does Asset Trade Smooth Real Income?," Review of International Economics, Wiley Blackwell, vol. 2(1), pages 13-26, February.
  2. Alan C. Stockman & Linda L. Tesar, 1990. "Tastes and Technology in a Two-Country Model of the Business Cycle: Explaining International Comovements," NBER Working Papers 3566, National Bureau of Economic Research, Inc.
  3. Stockman, Alan C. & Dellas, Harris, 1989. "International portfolio nondiversification and exchange rate variability," Journal of International Economics, Elsevier, vol. 26(3-4), pages 271-289, May.
  4. Devereux, Michael B. & Gregory, Allan W. & Smith, Gregor W., 1992. "Realistic cross-country consumption correlations in a two-country, equilibrium, business cycle model," Journal of International Money and Finance, Elsevier, vol. 11(1), pages 3-16, February.
  5. Michael R. Pakko, 1994. "Characterizing cross-country consumption correlations," Working Papers 1994-026, Federal Reserve Bank of St. Louis.
  6. John Y. Campbell & N. Gregory Mankiw, 1989. "Consumption, Income and Interest Rates: Reinterpreting the Time Series Evidence," NBER Chapters, in: NBER Macroeconomics Annual 1989, Volume 4, pages 185-246 National Bureau of Economic Research, Inc.
  7. Baxter, M. & Crucini, M., 1991. "Business Cycles and the Asset Structure of Foreign Trade," RCER Working Papers 316, University of Rochester - Center for Economic Research (RCER).
  8. Hall, Robert E, 1988. "Intertemporal Substitution in Consumption," Journal of Political Economy, University of Chicago Press, vol. 96(2), pages 339-57, April.
  9. Jones, Ronald W., 1972. "Activity analysis and real incomes: Analogies with production models," Journal of International Economics, Elsevier, vol. 2(3), pages 277-302, August.
  10. Epstein, Larry G & Zin, Stanley E, 1991. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: An Empirical Analysis," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 263-86, April.
  11. David Backus & Patrick Kehoe & Finn Kydland, 1992. "Dynamics of the trade balance and the terms of trade: the J-curve revisited," Discussion Paper / Institute for Empirical Macroeconomics 65, Federal Reserve Bank of Minneapolis.
  12. Hagiwara, May, 1994. "Volatility in the terms of trade with non-identical preferences," Journal of International Money and Finance, Elsevier, vol. 13(3), pages 319-341, June.
  13. Lucas, Robert Jr., 1982. "Interest rates and currency prices in a two-country world," Journal of Monetary Economics, Elsevier, vol. 10(3), pages 335-359.
  14. Backus, David K & Kehoe, Patrick J & Kydland, Finn E, 1994. "Dynamics of the Trade Balance and the Terms of Trade: The J-Curve?," American Economic Review, American Economic Association, vol. 84(1), pages 84-103, March.
  15. repec:fth:harver:1435 is not listed on IDEAS
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