Low Risk Sharing with Many Assets

Emile Marin and Sanjay Singh

No 2023-37, Working Paper Series from Federal Reserve Bank of San Francisco

Abstract: Classical contributions in international macroeconomics rely on goods-market mechanisms to reconcile the cyclicality of real exchange rates when financial markets are incomplete. However, cross-border trade in one domestic and one foreign-currency-denominated risk-free asset prohibits these mechanisms from breaking the pattern consistent with complete markets. In this paper, we characterize how goods markets drive exchange rate cyclicality, taking into account trade in risk-free and/or risky assets. We show that goods-market mechanisms come back into play, even when there is cross-border trade in two risk-free assets, as long as we allow for empirically plausible heterogeneity in the stochastic discount factors of domestic marginal investors.

Keywords: risk sharing; incomplete markets; exchange rates (search for similar items in EconPapers)
JEL-codes: E32 F31 F44 G15 (search for similar items in EconPapers)
Pages: 49
Date: 2023-11-30
New Economics Papers: this item is included in nep-ifn, nep-opm and nep-rmg
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Working Paper: Low Risk Sharing with Many Assets (2023)
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DOI: 10.24148/wp2023-37

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