Productivity, Preferences and UIP deviations in an Open Economy Business Cycle Model

We show that a flex-price two-sector open economy DSGE model can explain the poor degree of international risk sharing and exchange rate disconnect. We use a suite of model evaluation measures and examine the role of (i) traded and non-traded sectors; (ii) financial market incompleteness; (iii) preference shocks; (iv) deviations from UIP condition for the exchange rates; and (v) creditor status in net foreign assets. We find that there is a good case for both traded and non-traded productivity shocks as well as UIP deviations in explaining the puzzles.

Complete Markets Strikes Back: Revisiting Risk Sharing Tests under Discount Rate Heterogeneity

Recent risk sharing tests strongly reject the hypothesis of complete markets, because in the data: (1) the individual consumption comoves with income and (2) the consumption dispersion increases over the life cycle. In this paper, I revisit the implications of these risk sharing tests in the context of a complete market model with discount rate heterogeneity, which is extended to introduce the individual choices of effort in education. I .nd that a complete market model with discount rate heterogeneity can pass both types of the risk sharing tests. The endogenous positive correlation between income growth rate and patience makes the individual consumption comove with income, even if the markets are complete. I also show that this model is quantitatively admissible to account for both the observed comovement of consumption and income and the increase of consumption dispersion over the life cycle.

Consumption Inequality and Discount Rate Heterogeneity

Although standard incomplete market models can account for the magnitude of the rise in consumption inequality over the life cycle, they generate unrealistically concave age pro.les of consumption inequality and unrealistically less wealth inequality. In this paper, I investigate the role of discount rate heterogeneity on consumption inequality in the context of incomplete market life cycle models. The distribution of discount rates is estimated using moments from the wealth distribution. I .nd that the model with heterogeneous income pro.les (HIP) and discount rate heterogeneity can successfully account for the empirical age pro.le of consumption inequality, both in its magnitude and in its non-concave shape. Generating realistic wealth inequality, this simulated model also highlights the importance of ex ante heterogeneities as main sources of life time inequality.