Working Paper: CEPR ID: DP6192
Authors: Narayana Kocherlakota; Luigi Pistaferri
Abstract: We assume that individuals can fully insure themselves against cross-country shocks, but not against individual-specific shocks. We consider two particular models of limited risk-sharing: domestically incomplete markets (DI) and private information-Pareto optimal (PIPO) risk-sharing. For each model, we derive a restriction relating the cross-sectional distributions of consumption and real exchange rates. We evaluate these restrictions using household-level consumption data from the US and the UK. We show that the PIPO restriction fits the data well when households have a coefficient of relative risk aversion of around 5. The restrictions implied by the complete risk-sharing model and the DI model fare poorly.
Keywords: Market incompleteness; Pareto optimality; Precautionary savings; Real exchange rate
JEL Codes: D63; E21; F31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| risk aversion (D81) | ability to account for movements in REER (F32) |
| household consumption distributions (D10) | real exchange rates (F31) |
| negative moments of consumption distributions (D39) | growth rate of real exchange rate (F31) |
| PIPO model (C69) | accurate causal explanation for observed data (C90) |
| incomplete markets models (D52) | accurate causal explanation for observed data (C90) |
| domestically incomplete markets setup (D52) | growth rate of real exchange rate (F31) |