Household Heterogeneity and the Real Exchange Rate: Still a Puzzle
ECARES, Université Libre de Bruxelles; University of Paris XII - Department of Economics; Centre for Economic Policy Research (CEPR)
CEPR Discussion Paper No. DP7301
Kocherlakota and Pistaferri (EJ, 2007) [KP] develop a model of a world economy with private-information Pareto optimal (PIPO) risk sharing; in that model, the real exchange rate tracks relative domestic/foreign cross-sectional distributions of consumption. KP claim that the PIPO model fits the UK/US real exchange rate well.
This paper shows that the PIPO model is inconsistent with the UK/US data. Minor specification changes overturn KPs regression results. I also document that the relevant (relative) cross-sectional consumption moment is orders of magnitude more volatile than the real exchange rate, and less persistent. The link between the real exchange rage and consumption (heterogeneity) remains a puzzle.
Number of Pages in PDF File: 18
Keywords: heterogeneity, International risk sharing, real exchange rate
JEL Classification: F36, F41
Date posted: July 15, 2009