Foreign stock holdings: the role of information

The household finance literature documents a large fraction of the population not participating in stock markets. It is also puzzling that a much greater share of households do not participate in foreign stock markets. Recent empirical evidence points towards the role of information in determining agents' portfolio choices. I test these results into a model that incorporates information on agents' portfolio allocation decision. In the model, consumers can invest in both domestic and foreign stocks and to update their information set, agents have to pay a cost implying that consumers update their portfolio only infrequently. In addition, to account for the initial costs of acquiring information about stock investments, a version of the model also features an entry-cost to be paid at the first period by agents that decide to enter stock market. Agents that invest in foreign stocks are more attentive, updating their portfolio more frequently. After calibrating the model to match returns and volatility for the U.S. economy and di¤erent foreign stock investments, I obtain that the minimum entry cost necessary to drive households completely out of stock markets is large (and in line with the equity premium puzzle literature). However, once agents already invest in domestic stock markets, the minimum cost that would drive investors out of foreign stocks market is much smaller. The size of the latter minimum entry cost depends on model parameters assumptions, and small variations on risk aversion and uncertaintly about foreign asset returns can bring this entry cost down enough to justify the substancial non-participation in foreign stock markets.Stockholders ; Stock market

Aggregation and the PPP puzzle in a sticky-price model

We study the purchasing power parity (PPP) puzzle in a multi-sector, two-country, sticky- price model. Across sectors, firms differ in the extent of price stickiness, in accordance with recent microeconomic evidence on price setting in various countries. Combined with local currency pricing, this leads sectoral real exchange rates to have heterogeneous dynamics. We show analytically that in this economy, deviations of the real exchange rate from PPP are more volatile and persistent than in a counterfactual one-sector world economy that features the same average frequency of price changes, and is otherwise identical to the multi-sector world economy. When simulated with a sectoral distribution of price stickiness that matches the microeconomic evidence for the U.S. economy, the model produces a half-life of deviations from PPP of 39 months. In contrast, the half-life of such deviations in the counterfactual one-sector economy is only slightly above one year. As a by-product, our model provides a decomposition of this difference in persistence that allows a structural interpretation of the different approaches found in the empirical literature on aggregation and the real exchange rate. In particular, we reconcile the apparently conflicting findings that gave rise to the "PPP Strikes Back debate" (Imbs et al. 2005a,b and Chen and Engel 2005).Purchasing power parity ; Prices ; Foreign exchange rates

Evidence suggests that higher income households understand U.S. monetary policy better than those on low incomes

The way that the public responds to changes in monetary policy can be integral to whether such changes are successful. But how much do people really understand monetary policy? Using data from consumer surveys and inflation, interest rate and unemployment data, Carlos Carvalho and Fernanda Nechio find evidence that households do form expectations in a way that is consistent with the conduct of monetary policy. They also write that this evidence is more pronounced for households that have higher incomes

Board of Governors of the Federal Reserve System. Monetary Policy and Real Exchange Rate Dynamics in Sticky-Price Models ∗

The views in this paper are solely the responsibility of the authors and should not be interpreted as reflecting the views of the Federal Reserve Bank of San Francisco or th

Long-run impact of the crisis in Europe: reforms and austerity measures

The euro area faces its first sovereign debt crisis, highlighting the fiscal imbalances of member countries. Troubled countries are implementing austerity measures, with adjustments focusing on the short and medium run. However, a long-run solution to Europe's problems requires economic reforms that increase competitiveness and reduce labor costs in the peripheral countries. Such reforms would promote convergence of the euro-area economies and enhance the long-run sustainability of monetary union.European Union ; Debt ; Economic conditions - Europe ; Financial crises