Working Paper

Limited asset market participation and the consumption-real exchange rate anomaly

Abstract: Under efficient consumption risk sharing, as assumed in standard international business cycle models, a country's aggregate consumption rises relative to foreign consumption, when the country's real exchange rate depreciates. Yet, empirically, relative consumption and the real exchange rate are essentially uncorrelated. I show that this \"consumption-real exchange rate anomaly\" can be explained by a simple model in which a subset of households trade in complete financial markets, while the remaining households lead hand-to-mouth (HTM) lives. HTM behavior also generates greater volatility of the real exchange rate and of net exports, which likewise brings the model closer to the data.

JEL Classification: F36; F41; F47; G15;

Bibliographic Information

Provider: Federal Reserve Bank of Dallas

Part of Series: Globalization Institute Working Papers

Publication Date: 2010

Number: 41

Pages: 21 pages

Note: Published as: Kollmann, Robert (2012), "Limited Asset Market Participation and the Consumption-Real Exchange Rate Anomaly," Canadian Journal of Economics 45 (2): 556-584.