TY - JOUR AU - Benigno,Pierpaolo AU - Nisticò,Salvatore TI - International Portfolio Allocation under Model Uncertainty JF - National Bureau of Economic Research Working Paper Series VL - No. 14734 PY - 2009 Y2 - February 2009 UR - http://www.nber.org/papers/w14734 L1 - http://www.nber.org/papers/w14734.pdf N1 - Author contact info: Pierpaolo Benigno Dipartimento di Scienze Economiche e Aziendali Luiss Guido Carli Viale Romania 32 00197 Rome ITALY Tel: 39-0685225-552 E-Mail: pbenigno@luiss.it Salvatore Nisticò Università di Roma "La Sapienza" Dipartimento di Analisi Economiche e Sociali viale Aldo Moro 5 00185 Rome Italy Tel: +39.06.8522.5637 Fax: +39.06.8522.5949 E-Mail: salvatore.nistico@uniroma1.it AB - 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. ER -