[Seminaire CREM] Consumption risk sharing and households heterogeneity

Consumption risk sharing remains one of the major puzzles in international finance. The perfect correlation between one country's relative consumption and its real exchange rate, which is predicted by business cycle theory, is at odds with the data. We extend a standard international real business cycle model to allow for limited asset market participation. A fraction of households are excluded from financial markets, preventing them from smoothing consumption over time. We show how household heterogeneity combined with a low trade elasticity solves the anomaly. First, our model generates a realistic negative correlation between relative consumption and the real exchange rate. Second, cyclical inequality shapes the international transmission of a domestic productivity shock.