Discussion paper

DP7452 Limited Asset Market Participation and the Consumption-Real Exchange Rate Anomaly

Under efficient consumption risk sharing, as assumed in standard international business cycle models, a country?s aggregate consumption rises relative to foreign consumption, when the country?s real exchange rate depreciates. Yet, empirically, relative consumption and the real exchange rate are essentially uncorrelated. I show that this ?consumption-real exchange rate anomaly? can be explained by a simple model in which a subset of households trade in complete financial markets, while the remaining households lead hand-to-mouth (HTM) lives. HTM behavior also generates greater volatility of the real exchange rate and of net exports, which likewise brings the model closer to the data.

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Citation

Kollmann, R (2009), ‘DP7452 Limited Asset Market Participation and the Consumption-Real Exchange Rate Anomaly‘, CEPR Discussion Paper No. 7452. CEPR Press, Paris & London. https://cepr.org/publications/dp7452