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International Portfolio Allocation under Model Uncertainty

  • Pierpaolo Benigno
  • Salvatore Nisticò

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 orders@nber.org or to call 617 588-1405 to purchase the older version.

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File URL: http://www.nber.org/papers/w14734.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 14734.

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Date of creation: Feb 2009
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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.
Handle: RePEc:nbr:nberwo:14734
Note: AP IFM ME
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  1. Strzalecki, Tomasz, 2013. "Temporal Resolution of Uncertainty and Recursive Models of Ambiguity Aversion," Scholarly Articles 12967691, Harvard University Department of Economics.
  2. 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.
  3. Robert J. Shiller, 1993. "Aggregate Income Risks and Hedging Mechanisms," Cowles Foundation Discussion Papers 1048, Cowles Foundation for Research in Economics, Yale University.
  4. Riccardo Colacito & Mariano Croce, 2005. "Risks For The Long Run And The Real Exchange Rate," 2005 Meeting Papers 794, Society for Economic Dynamics.
  5. Nicolas Coeurdacier & Robert Kollmann & Philippe Martin, 2009. "International Portfolios with Supply, Demand and Redistributive Shocks," NBER Chapters, in: NBER International Seminar on Macroeconomics 2007, pages 231-263 National Bureau of Economic Research, Inc.
  6. Michael B. Devereux & Alan Sutherland, 2008. "Country Portfolios in Open Economy Macro Models," NBER Working Papers 14372, National Bureau of Economic Research, Inc.
  7. 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.
  8. Tomasz Strzalecki, . "Axiomatic Foundations of Multiplier Preferences," Working Paper 8239, Harvard University OpenScholar.
  9. 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.
  10. Giannis Vardas & Anastasios Xepapadeas, 2004. "Uncertainty Aversion and Robust Portfolio Choices," Working Papers 0408, University of Crete, Department of Economics.
  11. repec:spo:wpecon:info:hdl:2441/c8dmi8nm4pdjkuc9g708n2m4m is not listed on IDEAS
  12. Kollmann, Robert, 2006. "International Portfolio Equilibrium and the Current Account," CEPR Discussion Papers 5512, C.E.P.R. Discussion Papers.
  13. repec:spo:wpecon:info:hdl:2441/c8dmi8nm4pdjkuc9g821o6lsg is not listed on IDEAS
  14. 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.
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