Working Paper: CEPR ID: DP15550
Authors: Patrick Minford; Zhirong Ou; Zheyi Zhu
Abstract: We revisit the evidence on consumer risk-pooling and uncovered interest parity. Widely used single equation tests are strongly biased against both. Using the full-model, Indirect Inference test, which is unbiased and has Goldilocks power by Monte Carlo experiments, we find that both the risk-pooling hypothesis and its weaker UIP version are generally accepted as part of a full world DSGE model. The fact that the risk-pooling hypothesis, with its implication of strong cross-border consumer linkage, has passed this test with generally the highest p-value, suggests that it deserves serious attention from policy-makers looking for a relevant model to discuss international monetary and other business cycle issues.
Keywords: open economy; consumer riskpooling; UIP; full-model test; indirect inference
JEL Codes: C12; E12; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| single-equation tests (C20) | rejection of riskpooling hypothesis (D81) |
| single-equation tests (C20) | rejection of UIP (J65) |
| riskpooling hypothesis (G52) | acceptance (Y20) |
| UIP (J65) | acceptance (Y20) |
| riskpooling hypothesis (G52) | strong cross-border consumer linkage (F61) |
| full DSGE model (E13) | riskpooling hypothesis (G52) |
| full DSGE model (E13) | UIP (J65) |