Consumption Risk Sharing, the Real Exchange Rate, and Borders: Why Does the Exchange Rate Make Such a Di¤erence? Preliminary: First draft

This paper explores the nature of consumption risk-sharing within and across countries. A basic prediction of e ¢ cient risk sharing is that relative consumption growth rates across countries or regions should be positively re-lated to real exchange rate growth rates across the same areas. We provide a comprehensive investigation of this hypothesis in a multi-country and multi-regional data set. Controlling for consumption comparisons across national borders, we \u85nd signi\u85cant evidence of risk sharing. Incorporating the impact of borders, however, relative consumption growth is negatively related to real exchange rate changes. In line with previous work, we \u85nd that the border e¤ect is substantially (but not fully) accounted for by nominal exchange rate variability. We then ask whether standard open economy macro models can explain these features of the data. We argue that they cannot. In order to ex-plain the key role of the nominal exchange rate in deviations from cross country consumption risk sharing, it is necessary to combine multiple sources of shocks, both from supply and demand, ex-ante price setting, and incomplete \u85nancia