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Domestic Financial Frictions: Implications for International Risk Sharing, Real Exchange Rate Volatility and International Business Cycles

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  • Kollmann, Robert

Abstract

Under complete international financial markets, as assumed in standard international business cycle models, a country’s aggregate consumption rises relative to foreign consumption, in states of the world in which the country’s real exchange rate depreciates. Empirically, relative consumption spending and the real exchange rate are essentially uncorrelated. I show that this consumption-real exchange rate anomaly’ can be explained by a model in which only a fraction of households trade in complete financial markets, while the remaining households do not participate in financial markets, and thus act in a hand-to-mouth (HTM) manner. HTM behavior also generates a more volatile real exchange rate, which also brings the model closer to the data.

Suggested Citation

  • Kollmann, Robert, 2009. "Domestic Financial Frictions: Implications for International Risk Sharing, Real Exchange Rate Volatility and International Business Cycles," MPRA Paper 70348, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:70348
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    References listed on IDEAS

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    More about this item

    Keywords

    Domestic financial frictions; international risk sharing; real exchange rate; international business cycles;

    JEL classification:

    • E1 - Macroeconomics and Monetary Economics - - General Aggregative Models
    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • F3 - International Economics - - International Finance
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance
    • F6 - International Economics - - Economic Impacts of Globalization

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