International Risk-Sharing and the Transmission of Productivity Shocks

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  • 1 January 2003
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      • Published in RePEc
Abstract
A central puzzle in international finance is that real exchange rates are volatile and, in stark contradiction to e.cient risk-sharing, negatively correlated with relative consumptions across countries. This paper shows that a model with incomplete markets and a low price elasticity of tradables can account for these properties of real exchange rates. The low price elasticity stems from introducing distribution services, intensive in local inputs, which drive a wedge between producer and consumer prices and lower the impact of terms-of-trade changes on optimal agents. decisions. In our model, two very different patterns of the international transmission of productivity shocks generate the observed degree of risk-sharing: one associated with an improvement, the other with a worsening of the country's terms of trade and real exchange rate. We provide VAR evidence on the e.ect of technology shocks to U.S. manufacturing, identified through long-run restrictions, in support of the first transmission pattern. These findings are at odds with the presumption that terms-of-trade movements foster international risk-pooling.

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