DP6192 Household Heterogeneity and Real Exchange Rates
|Author(s):||Narayana Kocherlakota, Luigi Pistaferri|
|Publication Date:||March 2007|
|Keyword(s):||market incompleteness, Pareto optimality, precautionary savings, real exchange rate|
|JEL(s):||D63, E21, F31|
|Programme Areas:||International Macroeconomics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=6192|
We assume that individuals can fully insure themselves against cross-country shocks, but not against individual-specific shocks. We consider two particular models of limited risk-sharing: domestically incomplete markets (DI) and private information-Pareto optimal (PIPO) risk-sharing. For each model, we derive a restriction relating the cross-sectional distributions of consumption and real exchange rates. We evaluate these restrictions using household-level consumption data from the US and the UK. We show that the PIPO restriction fits the data well when households have a coefficient of relative risk aversion of around 5. The restrictions implied by the complete risk-sharing model and the DI model fare poorly.