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American Economic Journal: Macroeconomics: Vol. 4 No. 1 (January 2012)

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International Portfolio Allocation under Model Uncertainty

Article Citation

Benigno, Pierpaolo, and Salvatore Nisticò. 2012. "International Portfolio Allocation under Model Uncertainty." American Economic Journal: Macroeconomics, 4(1): 144-89.

DOI: 10.1257/mac.4.1.144

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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Authors

Benigno, Pierpaolo (LUISS "Guido Carli", Rome and EIEF)
Nisticò, Salvatore (U Rome "La Sapienza" and LUISS "Guido Carli", Rome)

JEL Classifications

C58: Financial Econometrics
F31: Foreign Exchange
G11: Portfolio Choice; Investment Decisions
G15: International Financial Markets

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American Economic Journal: Macroeconomics


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