Published and unpublished papers by Wei Xiao

Can Indeterminacy Resolve the Cross-country Correlation Puzzle?

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Journal of Economics Dynamics and Control 28 (2004), 2341-2366 (Download working paper version)

Are productivity shocks the only driving force of international business fluctuations? In this paper I argue that another source of uncertainty – changes in market expectations or “sunspots”  – is also important. One major shortcoming of existing IRBC models is the “cross-country correlation puzzle”: models tend to generate cross-country consumption correlations that are too high and output, investment and employment correlations that are too low when compared to the data. I show that with empirically supported level of increasing returns, an otherwise standard model possesses multiple, indeterminate convergent paths to the steady state, which allows for sunspots to influence the economy. The model displays time series properties that in many ways match the data better than the conventional model. It is especially successful in generating realistic consumption and output correlations. 


Written by wxiao

January 21, 2009 at 6:55 pm

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