International Risk Sharing and the Transmission of Productivity Shocks

This paper shows that standard international business cycle models can be reconciled with the empirical evidence on the lack of consumption risk sharing. First, we show analytically that with incomplete asset markets productivity disturbances can have large un-insurable effects on wealth, depending on the value of the trade elasticity and shock persistence. Second, we investigate these findings quantitatively in a model calibrated to the U.S. economy. With the low trade elasticity estimated via a method of moments procedure, the consumption risk of productivity shocks is magnified by high terms of trade and real exchange rate (RER) volatility. Strong wealth effects in response to shocks raise the demand for…

• UO
  University of Pennsylvania
• EC
  European Commission
• BD
  Banca d'Italia