International Portfolio Allocation under Model Uncertainty
This paper proposes an explanation of the international home bias in equity based on ambiguity aversion. Doubts imply an additional hedging motif driven by the interaction between real exchange rate risk and ambiguity aversion. What matters is the long-run as opposed to the short-run risk. Domestic equity is a good hedge with respect to long-run real exchange rate risk even when bonds are traded. The higher is the degree of ambiguity aversion, the stronger is the home bias. We identify the degree of ambiguity aversion with detection error probabilities and show that our framework is able to explain a large share of the observed US home bias, as well as other stylized facts on US cross-border asset holdings. Without doubts, a standard open-economy macroeconomic model would be unsuccessful along all these dimensions. An older version of this paper is available at http://www.nber.org/papers/w14734.rev0.pdf to NBER subscribers and those in domains eligible for free downloads. Individual purchasers of papers are directed to email firstname.lastname@example.org or to call 617 588-1405 to purchase the older version.
|Date of creation:||Feb 2009|
|Date of revision:|
|Publication status:||published as Pierpaolo Benigno & Salvatore Nistico, 2012. "International Portfolio Allocation under Model Uncertainty," American Economic Journal: Macroeconomics, American Economic Association, vol. 4(1), pages 144-89, January.|
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