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Precautionary risks for an open economy

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  • Ferreira, Alex
  • Matos, Paulo

Abstract

Our empirical investigation reveals that the variance of foreign consumption is much higher than the variance of domestic consumption growth for the domestic United States of America (US) resident. We show that precautionary savings in foreign currency arise because of this volatility differential between domestic and imported consumption growth. These open economy stochastic discount factors are later shown to be strongly positively correlated with the US business cycle. We present evidence that the precautionary currency risk must be seen through the lens of an open economy model rather than the traditional durable/non-durable closed economy separation.

Suggested Citation

  • Ferreira, Alex & Matos, Paulo, 2020. "Precautionary risks for an open economy," International Review of Economics & Finance, Elsevier, vol. 70(C), pages 154-167.
    • Handle: RePEc:eee:reveco:v:70:y:2020:i:c:p:154-167
    DOI: 10.1016/j.iref.2020.06.034
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    Cited by:

    1. Fernanda Gonçalves & Giuliano Ferreira & Alex Ferreira & Pedro Scatimburgo, 2022. "Currency returns and systematic risk," Manchester School, University of Manchester, vol. 90(6), pages 609-647, December.

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    More about this item

    Keywords

    Risk; Exchange rate; Consumption; Imports;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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