International Risk Sharing and the Transmission of Productivity Shocks

49 Pages Posted: 1 Feb 2005

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)

Sylvain Leduc

Federal Reserve Banks - Federal Reserve Bank of San Francisco

Multiple version iconThere are 2 versions of this paper

Date Written: November 2004

Abstract

A central puzzle in international finance is that real exchange rates are volatile and, in stark contradiction to efficient risk sharing, negatively correlated with cross-country consumption ratios. This Paper shows that a standard international business cycle model with incomplete asset markets augmented with distribution services can account quantitatively for these properties of real exchange rates. Distribution services, intensive in local inputs, drive a wedge between producer and consumer prices, thus lowering the impact of terms-of-trade changes on optimal agents' decisions. This reduces the price elasticity of tradables separately from assumptions on preferences. Two very different patterns of the international transmission of positive technology shocks generate the observed degree of risk sharing: one associated with improving, the other with deteriorating terms of trade and real exchange rate. In both cases, large equilibrium swings in international relative prices magnify consumption risk due to country-specific shock, running counter to risk sharing. Suggestive evidence on the effect of productivity changes in US manufacturing is found in support of the fist transmission pattern, questioning the presumption that terms-of-trade movements in response to supply shocks invariably foster international risk pooling.

Keywords: Incomplete asset markets, distribution cost, consumption-real exchange rate correlation puzzle

JEL Classification: F32, F33, F41

Suggested Citation

Corsetti, Giancarlo and Dedola, Luca and Leduc, Sylvain, International Risk Sharing and the Transmission of Productivity Shocks (November 2004). CEPR Discussion Paper No. 4746. Available at SSRN: https://ssrn.com/abstract=654543

Giancarlo Corsetti (Contact Author)

University of Cambridge ( email )

University of Rome III - Department of Economics ( email )

via Ostiense 139
Rome, 00154
Italy
+39 06 5737 4056 (Phone)
+39 06 5737 4093 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Luca Dedola

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Sylvain Leduc

Federal Reserve Banks - Federal Reserve Bank of San Francisco ( email )

101 Market Street
San Francisco, CA 94105
United States

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
26
Abstract Views
1,567
PlumX Metrics