DP8810 Portfolio Allocation and International Risk Sharing

Author(s): Gianluca Benigno, Hande Küçük
Publication Date: February 2012
Keyword(s): Consumption-Real Exchange Rate anomaly, Incomplete Financial Markets, International Risk Sharing, Portfolio choice
JEL(s): F31, F41
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=8810

We show that recent explanations of the consumption-real exchange rate anomaly which rely on goods and financial market frictions are not robust to introducing just one additional international asset. When portfolios are selected optimally, international trade in two nominal bonds implies a consumption-real exchange rate correlation that is too high compared to the data even when there are many shocks. Monetary policy specification plays a potentially important role for the degree of risk sharing provided by nominal bonds, both in the benchmark model with only tradable and non-tradable sector supply shocks and also in the model which allows for news or quality (i-pod) shocks.