International Risk Cycles

Francois Gourio, Michael Siemer, Adrien Verdelhan
2011 Social Science Research Network  
This paper presents a two-country real business cycle model with two novel features: (1) exogenous shocks to worldwide uncertainty, (2) heterogeneous exposures to the world aggregate shock. We show that these two features lead to significant progress in tackling internationational finance puzzles. When world risk increases, investment decreases and a worldwide recession follows, even in the absence of technology shocks. Capital pulls out of the riskier country, which experiences the largest
more » ... ces the largest recession. Both stock markets tank and the high interest rate currency depreciates. The model thus provides a rationale for the existence of international equity and currency risk premia, and links them to macroeconomic dynamics. Empirically, we measure the response of macroeconomic aggregates and exchange rates to an aggregate volatility shock, and find support for the model's mechanism.
doi:10.2139/ssrn.1670723 fatcat:6bwmb4sor5hvbnnadrs4etz4mq