The extent of interna- tional risk sharing can also be affected by the completeness of the...

 

Transcribed Image Text:

The extent of interna- tional risk sharing can also be affected by the completeness of the international financial markets. In class, we have analyzed the optimal risk sharing under the assumption of market completeness. In this exercise, we will analyze international risk sharing under a special case of market incompleteness. Consider again the international risk sharing model with two periods and two countries (Home and Foreign), and the utility function u(c) = . Assume that global financial markets are incomplete and only non-state-contingent assets are traded: a one-period risk-free bond b. The bond has a price q in period 1(q = 1/R), and pays one unit of output in period 2 in all states of nature. a) Set up the optimization problem of the representative household. S b) Derive the Euler equation for consumption, c) Are the consumption growth rates the same for Home and Foreign? Interpret your result. 100 The extent of interna- tional risk sharing can also be affected by the completeness of the international financial markets. In class, we have analyzed the optimal risk sharing under the assumption of market completeness. In this exercise, we will analyze international risk sharing under a special case of market incompleteness. Consider again the international risk sharing model with two periods and two countries (Home and Foreign), and the utility function u(c) = . Assume that global financial markets are incomplete and only non-state-contingent assets are traded: a one-period risk-free bond b. The bond has a price q in period 1(q = 1/R), and pays one unit of output in period 2 in all states of nature. a) Set up the optimization problem of the representative household. S b) Derive the Euler equation for consumption, c) Are the consumption growth rates the same for Home and Foreign? Interpret your result. 100

Answer rating: 100% (QA)

a The optimization problem of the representative household is to maximize its expected lifetime utility subject to the budget constraint Since there a... View the full answer