Household Heterogeneity and Real Exchange Rates

54 Pages Posted: 20 May 2008

See all articles by Narayana Kocherlakota

Narayana Kocherlakota

University of Minnesota - Twin Cities - Department of Economics

Luigi Pistaferri

Stanford University; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: March 2007

Abstract

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.

Keywords: Market incompleteness, Pareto optimality, precautionary savings, real exchange rate

JEL Classification: D63, E21, F31

Suggested Citation

Kocherlakota, Narayana and Pistaferri, Luigi, Household Heterogeneity and Real Exchange Rates (March 2007). CEPR Discussion Paper No. DP6192. Available at SSRN: https://ssrn.com/abstract=1134233

Narayana Kocherlakota (Contact Author)

University of Minnesota - Twin Cities - Department of Economics ( email )

271 19th Avenue South
Minneapolis, MN 55455
United States
612-625-5318 (Phone)
612-624-0209 (Fax)

HOME PAGE: http://www.econ.umn.edu/~nkocher/

Luigi Pistaferri

Stanford University ( email )

Stanford, CA 94305
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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