The International Risk-Sharing Puzzle is at Business-Cycle and Lower Frequency

34 Pages Posted: 23 Feb 2012

See all articles by Giancarlo Corsetti

Giancarlo Corsetti

University of Cambridge; University of Rome III - Department of Economics; Centre for Economic Policy Research (CEPR)

Luca Dedola

Bank of Italy; European Central Bank (ECB)

Francesca Viani

Banco de España

Multiple version iconThere are 2 versions of this paper

Date Written: February 23, 2012

Abstract

We decompose the correlation between relative consumption and the real exchange rate into its dynamic components at different frequencies. Using multivariate spectral analysis techniques we show that, at odds with a high degree of risk-sharing, in most OECD countries the dynamic correlation tends to be quite negative, and significantly so, at frequencies lower than two years - the appropriate frequencies for assessing the performance of international business cycle models. Theoretically, we show that the dynamic correlation over different frequencies predicted by standard open-economy models is the sum of two terms: a term constant across frequencies, which can be negative when uninsurable risk is large; and a term variable across frequencies, which in bond economies is necessarily positive, reflecting the insurance that intertemporal trade provides against forecastable contingencies. Numerical analysis suggests that leading mechanisms proposed by the literature to account for the puzzle are consistent with the evidence across the spectrum.

Keywords: consumption-exchange rate anomaly, incomplete markets, frequency domain analysis

JEL Classification: F41, F42

Suggested Citation

Corsetti, Giancarlo and Dedola, Luca and Viani, Francesca, The International Risk-Sharing Puzzle is at Business-Cycle and Lower Frequency (February 23, 2012). Banco de Espana Working Paper No. 1212, Available at SSRN: https://ssrn.com/abstract=2009795 or http://dx.doi.org/10.2139/ssrn.2009795

Giancarlo Corsetti (Contact Author)

University of Cambridge ( email )

University of Rome III - Department of Economics ( email )

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Luca Dedola

Bank of Italy ( email )

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European Central Bank (ECB) ( email )

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Francesca Viani

Banco de España ( email )

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Spain

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