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International Portfolio Allocation under Model Uncertainty

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  • Pierpaolo Benigno
  • Salvatore Nistic�

Abstract

This paper revisits an old argument, hedging real exchange rate risk, as an explanation of the international home bias in equity. In a dynamic model, the relevant risk to be hedged is the long-run risk as opposed to the short-run risk. Domestic equity is indeed a good hedge with respect to long-run real-exchange-rate risk. Two new frameworks are able to explain a large share of the observed US home bias: a model with Hansen-Sargent preferences in which agents fear model misspecification and a model with Epstein-Zin preferences. These two models are also immune to the risk-free rate puzzle. (JEL C58, F31, G11, G15)

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Bibliographic Info

Article provided by American Economic Association in its journal American Economic Journal: Macroeconomics.

Volume (Year): 4 (2012)
Issue (Month): 1 (January)
Pages: 144-89

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Handle: RePEc:aea:aejmac:v:4:y:2012:i:1:p:144-89

Note: DOI: 10.1257/mac.4.1.144
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  1. Tomasz Strzalecki, 2011. "Axiomatic Foundations of Multiplier Preferences," Levine's Working Paper Archive 786969000000000126, David K. Levine.
  2. Kollmann, Robert, 2006. "International Portfolio Equilibrium and the Current Account," CEPR Discussion Papers 5512, C.E.P.R. Discussion Papers.
  3. Coeurdacier, Nicolas & Kollmann, Robert & Martin, Philippe, 2007. "International Portfolios with Supply, Demand and Redistributive Shocks," CEPR Discussion Papers 6482, C.E.P.R. Discussion Papers.
  4. Riccardo Colacito & Mariano M. Croce, 2011. "Risks for the Long Run and the Real Exchange Rate," Journal of Political Economy, University of Chicago Press, vol. 119(1), pages 153 - 181.
  5. Giannis Vardas & Anastasios Xepapadeas, 2004. "Uncertainty Aversion and Robust Portfolio Choices," Working Papers 0408, University of Crete, Department of Economics.
  6. Robert J. Shiller, 1993. "Aggregate Income Risks and Hedging Mechanisms," NBER Working Papers 4396, National Bureau of Economic Research, Inc.
  7. Hansen, Lars Peter & Sargent, Thomas J., 2005. "Robust estimation and control under commitment," Journal of Economic Theory, Elsevier, vol. 124(2), pages 258-301, October.
  8. Michael B. Devereux & Alan Sutherland, 2008. "Country portfolios in open economy macro models," Globalization and Monetary Policy Institute Working Paper 09, Federal Reserve Bank of Dallas.
  9. Harold L. Cole & Maurice Obstfeld, 1989. "Commodity Trade and International Risk Sharing: How Much Do Financial Markets Matter?," NBER Working Papers 3027, National Bureau of Economic Research, Inc.
  10. Tomasz Strzalecki, 2013. "Temporal Resolution of Uncertainty and Recursive Models of Ambiguity Aversion," Econometrica, Econometric Society, vol. 81(3), pages 1039-1074, 05.
  11. repec:spo:wpecon:info:hdl:2441/c8dmi8nm4pdjkuc9g708n2m4m is not listed on IDEAS
  12. David Backus & Bryan Routledge & Stanley Zin, 2004. "Exotic Preferences for Macroeconomists," Working Papers 04-20, New York University, Leonard N. Stern School of Business, Department of Economics.
  13. repec:spo:wpecon:info:hdl:2441/c8dmi8nm4pdjkuc9g821o6lsg is not listed on IDEAS
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