Domestic Financial Frictions: Implications for International Risk Sharing, Real Exchange Rate Volatility and International Business Cycles

Kollmann, Robert (2009): Domestic Financial Frictions: Implications for International Risk Sharing, Real Exchange Rate Volatility and International Business Cycles.

Abstract

Under complete international financial markets, as assumed in standard international business cycle models, a country’s aggregate consumption rises relative to foreign consumption, in states of the world in which the country’s real exchange rate depreciates. Empirically, relative consumption spending and the real exchange rate are essentially uncorrelated. I show that this consumption-real exchange rate anomaly’ can be explained by a model in which only a fraction of households trade in complete financial markets, while the remaining households do not participate in financial markets, and thus act in a hand-to-mouth (HTM) manner. HTM behavior also generates a more volatile real exchange rate, which also brings the model closer to the data.

• Item Type: MPRA Paper
• Language: English
• Keywords: Domestic financial frictions, international risk sharing, real exchange rate, international business cycles
• Subjects: E - Macroeconomics and Monetary Economics > E1 - General Aggregative Models; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles; F - International Economics > F3 - International Finance; F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance; F - International Economics > F6 - Economic Impacts of Globalization

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