Elastic Attention, Risk Sharing, and International Comovements

49 Pages Posted: 19 Dec 2015 Last revised: 26 Sep 2023

Date Written: December 2015

Abstract

This working paper was written by Wei Li (University of Hong Kong), Yulei Luo (University of Hong Kong) and Jun Nie (Federal Reserve Bank of Kansas City).

In this paper we examine the effects of elastic information-processing capacity (or elastic attention) proposed in Sims (2010) on international consumption and income correlations in a tractable small open economy (SOE) model with exogenous income processes. We find that in the presence of capital mobility in financial markets, elastic attention due to a fixed information-processing cost lowers international consumption correlations by generating heterogeneous consumption adjustments to income shocks across countries facing different macroeconomic uncertainty. In addition, we show that elastic attention can also improve the model's predictions for other key moments of the joint dynamics of consumption and income. Finally, we show that the main conclusions of our benchmark model do not change in an extension with capital accumulation.

Keywords: Rational Inattention, Elastic Capacity, Risk Sharing, International Consumption Correlations

JEL Classification: D83, E21, F41, G15

Suggested Citation

Institute for Monetary and Financial Research, Hong Kong, Elastic Attention, Risk Sharing, and International Comovements (December 2015). Hong Kong Institute for Monetary and Financial Research (HKIMR) Research Paper WP No. 26/2015, Journal of Economic Dynamics and Control, Vol. 79, 2017, Available at SSRN: https://ssrn.com/abstract=2705252 or http://dx.doi.org/10.2139/ssrn.2705252

Hong Kong Institute for Monetary and Financial Research (Contact Author)

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