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Net Foreing Assets and Imperfect Pass-through: The Consumption-Real Exchange Rate Anomaly

  • Vicente Tuesta
  • Jorge Selaive

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 asses the importance of international financial frictions in this issue by constructing an incomplete market model with stationary net foreign asset (NFA) and imperfect pass-through. In this paper, there is a cost of bond holding that allows us to incorporate the dynamics of the NFA position into the risk-sharing condition. On the theoretical grounds, our results suggest that the dynamics of the NFA position may account for the lack of risk-sharing across countries. In addition, the imperfect pass-through 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 Society for Economic Dynamics in its series 2004 Meeting Papers with number 203.

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Date of creation: 2004
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Handle: RePEc:red:sed004:203
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