Speaker:Roman Sysuyev (University of Rochester)
Venue: MNB-Visitor Centre
Time: 14.00 pm(!), Monday(!), February 8, 2010
Abstract
The correlation between consumption levels in different countries is much lower than what is suggested by models of efficient risk sharing with common beliefs. Relatedly, observed asset positions of consumers in different countries suggest a „bias" toward home-country investments, even for countries where asset markets are quite well developed. This paper examines a mechanism that can generate these observations by considering preferences that allow ambiguity aversion of the sort illustrated by the Ellsberg Paradox. A key assumption is that the home consumer is more ambiguous about the process generating productivity shocks in the foreign country than about that in the home country. In the context of a two-country dynamic general equilibrium model with technology shocks, it is shown that the model generates low consumption correlations, higher output correlations, biased financial portfolios, and biased real investment flows. Moreover, a very modest amount of ambiguity suffices in order to generate the main findings: with ambiguity at or above a certain threshold, consumers „choose autarky", i.e., they choose to have exactly zero consumption correlation with foreigners (and a 100% home-biased portfolio)