DP7301 Household Heterogeneity and the Real Exchange Rate: Still a Puzzle

Author(s):	Robert Kollmann
Publication Date:	May 2009
Keyword(s):	heterogeneity, International risk sharing, real exchange rate
JEL(s):	F36, F41
Programme Areas:	International Macroeconomics
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=7301

Kocherlakota and Pistaferri (EJ, 2007) [KP] develop a model of a world economy with private-information Pareto optimal (PIPO) risk sharing; in that model, the real exchange rate tracks relative domestic/foreign cross-sectional distributions of consumption. KP claim that the PIPO model fits the UK/US real exchange rate well. This paper shows that the PIPO model is inconsistent with the UK/US data. Minor specification changes overturn KP?s regression results. I also document that the relevant (relative) cross-sectional consumption moment is orders of magnitude more volatile than the real exchange rate, and less persistent. The link between the real exchange rage and consumption (heterogeneity) remains a puzzle.