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International Portfolio Allocation under Model Uncertainty

  • Pierpaolo Benigno
  • Salvatore Nistic�

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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File URL: http://www.aeaweb.org/articles.php?doi=10.1257/mac.4.1.144
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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
Contact details of provider: Web page: https://www.aeaweb.org/aej-macro
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  2. Giannis Vardas & Anastasios Xepapadeas, 2004. "Uncertainty Aversion and Robust Portfolio Choices," Working Papers 0408, University of Crete, Department of Economics.
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