Discussion paper

DP6192 Household Heterogeneity and Real Exchange Rates

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.


Pistaferri, L and N Kocherlakota (eds) (2007), “DP6192 Household Heterogeneity and Real Exchange Rates”, CEPR Press Discussion Paper No. 6192. https://cepr.org/publications/dp6192