International Disaster Risk, Business Cycles, and Exchange Rates

Adrien Verdelhan () and Francois Gourio

No 435, 2010 Meeting Papers from Society for Economic Dynamics

Abstract: What accounts for the unprecedented decline in world trade during the crisis? What have been the consequences of shifting risk appetites for international capital flows? How have they differed across developed and developing economies? We answer these questions in an international real business cycle model with time-varying disaster risk. We interpret the recent crisis as an increase in the probability of disasters. It leads to a decrease of investment and a recession worldwide. In our model, capital pulls out of the riskier country, which experience the largest recession. Hence, the real exchange rate depreciates. Both stock markets tank, and short-term safe interest rates fall.

Date: 2010
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