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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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File URL: http://www.aeaweb.org/aej/mac/data/2010-0007_data.zip
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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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  1. Robert J. Shiller, 1993. "Aggregate Income Risks and Hedging Mechanisms," NBER Working Papers 4396, National Bureau of Economic Research, Inc.
  2. Strzalecki, Tomasz, 2013. "Temporal Resolution of Uncertainty and Recursive Models of Ambiguity Aversion," Scholarly Articles 12967691, Harvard University Department of Economics.
  3. repec:spo:wpecon:info:hdl:2441/c8dmi8nm4pdjkuc9g821o6lsg is not listed on IDEAS
  4. Michael B. Devereux & Alan Sutherland, 2011. "Country Portfolios In Open Economy Macro‐Models," Journal of the European Economic Association, European Economic Association, vol. 9(2), pages 337-369, 04.
  5. Giannis Vardas & Anastasios Xepapadeas, 2004. "Uncertainty Aversion and Robust Portfolio Choices," Working Papers 0408, University of Crete, Department of Economics.
  6. David K. Backus & Bryan R. Routledge & Stanley E. Zin, 2005. "Exotic Preferences for Macroeconomists," NBER Chapters, in: NBER Macroeconomics Annual 2004, Volume 19, pages 319-414 National Bureau of Economic Research, Inc.
  7. Kollmann, Robert, 2006. "International Portfolio Equilibrium and the Current Account," CEPR Discussion Papers 5512, C.E.P.R. Discussion Papers.
  8. Nicolas Coeurdacier & Robert Kollmann & Philippe Martin, 2007. "International Portfolios with Supply, Demand and Redistributive Shocks," NBER Working Papers 13424, National Bureau of Economic Research, Inc.
  9. Riccardo Colacito & Mariano Croce, 2005. "Risks For The Long Run And The Real Exchange Rate," 2005 Meeting Papers 794, Society for Economic Dynamics.
  10. Tomasz Strzalecki, 2011. "Axiomatic Foundations of Multiplier Preferences," Econometrica, Econometric Society, vol. 79(1), pages 47-73, 01.
  11. 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.
  12. repec:spo:wpecon:info:hdl:2441/c8dmi8nm4pdjkuc9g708n2m4m is not listed on IDEAS
  13. David K. Backus & Federico Gavazzoni & Christopher Telmer & Stanley E. Zin, 2010. "Monetary Policy and the Uncovered Interest Parity Puzzle," NBER Working Papers 16218, National Bureau of Economic Research, Inc.
  14. 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.
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