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International business cycles with endogenous incomplete markets

  • Patrick J. Kehoe
  • Fabrizio Perri

Backus, Kehoe and Kydland (1992), Baxter and Crucini (1995) and Stockman and Tesar (1995) find two major discrepancies between standard international business cycle models with complete markets and the data: In the models, cross-country correlations are much higher for consumption than for output, while in the data the opposite is true; and cross-country correlations of employment and investment are negative, while in the data they are positive. This paper introduces a friction into a standard model that helps resolve these anomalies. The friction is that international loans are imperfectly enforceable; any country can renege on its debts and suffer the consequences for future borrowing. To solve for equilibrium in this economy with endogenous incomplete markets, the methods of Marcet and Marimon (1999) are extended. Incorporating the friction helps resolve the anomalies more than does exogenously restricting the assets that can be traded.

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Paper provided by Federal Reserve Bank of Minneapolis in its series Staff Report with number 265.

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Date of creation: 2000
Date of revision:
Handle: RePEc:fip:fedmsr:265
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  1. Eaton, J. & Fernandez, R., 1995. "Sovereign Debt," Papers 37, Boston University - Department of Economics.
  2. Timothy J Kehoe & David K Levine, 1993. "Debt Constrained Asset Markets," Levine's Working Paper Archive 1276, David K. Levine.
  3. Harold L. Cole & Maurice Obstfeld, 1989. "Commodity Trade and International Risk Sharing: How Much Do Financial Markets Matter?," NBER Working Papers 3027, National Bureau of Economic Research, Inc.
  4. Albert Marcet & Ramon Marimon, 2011. "Recursive Contracts," CEP Discussion Papers dp1055, Centre for Economic Performance, LSE.
  5. Alvarez, Fernando & Jermann, Urban J, 2001. "Quantitative Asset Pricing Implications of Endogenous Solvency Constraints," Review of Financial Studies, Society for Financial Studies, vol. 14(4), pages 1117-51.
  6. Edward C. Prescott, 1986. "Theory ahead of business cycle measurement," Staff Report 102, Federal Reserve Bank of Minneapolis.
  7. Kydland, Finn E. & Prescott, Edward C., 1980. "Dynamic optimal taxation, rational expectations and optimal control," Journal of Economic Dynamics and Control, Elsevier, vol. 2(1), pages 79-91, May.
  8. Abreu, Dilip, 1988. "On the Theory of Infinitely Repeated Games with Discounting," Econometrica, Econometric Society, vol. 56(2), pages 383-96, March.
  9. Patrick J. Kehoe & Fabrizio Perri, 2000. "International Business Cycles with Endogenous Incomplete Markets," NBER Working Papers 7870, National Bureau of Economic Research, Inc.
  10. 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).
  11. Timothy J. Kehoe & David K. Levine, 2000. "Liquidity Constrained vs. Debt Constrained Markets," Levine's Working Paper Archive 14, David K. Levine.
  12. Kehoe, Timothy J & Levine, David K, 2001. "Liquidity Constrained Markets versus Debt Constrained Markets," Econometrica, Econometric Society, vol. 69(3), pages 575-98, May.
  13. V. V. Chari & Patrick J Kehoe, 1998. "Sustainable Plans," Levine's Working Paper Archive 600, David K. Levine.
  14. Kocherlakota, Narayana R, 1996. "Implications of Efficient Risk Sharing without Commitment," Review of Economic Studies, Wiley Blackwell, vol. 63(4), pages 595-609, October.
  15. David K. Backus & Patrick J. Kehoe & Finn E. Kydland, 1991. "International real business cycles," Staff Report 146, Federal Reserve Bank of Minneapolis.
  16. Ethan Ligon & Jonathan P. Thomas & Tim Worrall, 2000. "Mutual Insurance, Individual Savings and Limited Commitment," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 3(2), pages 216-246, April.
  17. Kollmann, Robert, 1996. "Incomplete asset markets and the cross-country consumption correlation puzzle," Journal of Economic Dynamics and Control, Elsevier, vol. 20(5), pages 945-961, May.
  18. 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.
  19. David K. Backus & Patrick J. Kehoe & Finn E. Kydland, 1993. "International business cycles: theory vs. evidence," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 14-29.
  20. Fernando Alvarez & Urban J. Jermann, 2000. "Efficiency, Equilibrium, and Asset Pricing with Risk of Default," Econometrica, Econometric Society, vol. 68(4), pages 775-798, July.
  21. Ethan Ligon & Jonathan P Thomas & Tim Worrall, 1997. "Informal Insurance Arrangements in Village Economies," CRIEFF Discussion Papers 9705, Centre for Research into Industry, Enterprise, Finance and the Firm.
  22. Fernando Alvarez & Urban J. Jermann, 1998. "Asset Pricing when Risk Sharing is Limited by Default," NBER Working Papers 6476, National Bureau of Economic Research, Inc.
  23. Baxter, M., 1994. "International Trade and Business Cycles," RCER Working Papers 390, University of Rochester - Center for Economic Research (RCER).
  24. Cole, Harold, 1988. "Financial Structure and International Trade," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 29(2), pages 237-59, May.
  25. repec:oup:restud:v:60:y:1993:i:1:p:175-95 is not listed on IDEAS
  26. Baxter, Marianne, 1995. "International trade and business cycles," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 35, pages 1801-1864 Elsevier.
  27. repec:oup:restud:v:60:y:1993:i:4:p:865-88 is not listed on IDEAS
  28. repec:oup:restud:v:48:y:1981:i:2:p:289-309 is not listed on IDEAS
  29. Heathcote, Jonathan & Perri, Fabrizio, 1999. "Financial Autarky and International Business Cycles," SSE/EFI Working Paper Series in Economics and Finance 320, Stockholm School of Economics, revised 30 Apr 2000.
  30. Attanasio, Orazio & Rios-Rull, Jose-Victor, 2000. "Consumption smoothing in island economies: Can public insurance reduce welfare?," European Economic Review, Elsevier, vol. 44(7), pages 1225-1258, June.
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