Betting against your neighbor: a quantitative investigation

We investigate a two-country model of real business cycles along the lines of Backus, Kehoe, and Kydland (1992) with one new feature: country one residents are ambiguous [along the lines of Epstein (2001)] about the productivity shocks of country two and vice versa. The model is calibrated and solved numerically. In equilibrium, because domestic residents are ambiguity-averse, they bet against productivity abroad being high, thus lowering their holding of foreign equity relative to the benchmark, no-ambiguity model. Thus, consumption correlations across countries fall significantly. Moreover, foreign real investment behaves differently than in the benchmark mod