Household heterogeneity and real exchange rates

Narayana Kocherlakota and Luigi Pistaferri

No 372, Staff Report from Federal Reserve Bank of Minneapolis

Abstract: Typical incomplete markets models in international economics make two assumptions. First, households are not able to fully insure themselves against country-specific shocks. Second, there is a representative household within each country, so that households are fully insured against idiosyncratic shocks. We assume instead that cross-household risk-sharing is limited within countries, but cross-country risk-sharing is complete. We consider two types of limited risk-sharing: domestically incomplete markets (DI) and private information-Pareto optimal (PIPO) risk-sharing. We show that the models imply distinct restrictions between the cross-sectional distributions of consumption and real exchange rates. We evaluate these restrictions using household-level consumption data from the United States and the United Kingdom. We show that the PIPO restriction fits the data well when households have a coefficient of relative risk aversion of around 5. The analogous restrictions implied by the representative agent model and the DI model are rejected at conventional levels of significance.

Keywords: Markets (search for similar items in EconPapers)
Date: 2006
New Economics Papers: this item is included in nep-cba, nep-dge and nep-fmk
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Citations: View citations in EconPapers (2)

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Related works:
Journal Article: Household Heterogeneity and Real Exchange Rates (2007)
Working Paper: Household Heterogeneity and Real Exchange Rates (2007)
Working Paper: Household Heterogeneity and Real Exchange Rates (2006)
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