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.