International Business Cycles and Risk Sharing with Uncertainty Shocks and Recursive Preferences

Working Papers ECARES from ULB -- Universite Libre de Bruxelles

Abstract: This paper analyzes the effects of output volatility shocks on the dynamics of consumption, trade flows and the real exchange rate, in a two-country, two-good world with consumption home bias, recursive preferences, and complete financial markets. When the risk aversion coefficient exceeds the inverse of the intertemporal substitution elasticity, then an exogenous rise in a country’s output volatility triggers a wealth transfer to that country, to compensate for the greater riskiness of the country’s output stream. This risk sharing transfer raises the country’s consumption, lowers its trade balance and appreciates its real exchange rate. In the recursive preferences framework here, volatility shocks account for a non-negligible share of the fluctuations of net exports, net foreign assets and the real exchange rate. These shocks help to explain the high empirical volatility of the real exchange rate and the disconnect between relative consumption and the real exchange rate.

Keywords: international business cycles; international risk sharing; external balance; exchange rate; volatility; consumption-real exchange rate anomaly (search for similar items in EconPapers)
JEL-codes: F31 F32 F36 F41 F43 (search for similar items in EconPapers)
Pages: 24 p.
Date: 2016-03
New Economics Papers: this item is included in nep-dge, nep-opm, nep-pke and nep-upt
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Citations: View citations in EconPapers (34)

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Related works:
Journal Article: International business cycles and risk sharing with uncertainty shocks and recursive preferences (2016)
Working Paper: International Business Cycles and Risk Sharing with Uncertainty Shocks and Recursive Preferences (2016)
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