Optimal and Naive Diversification in Currency Markets

@article{Ackermann2017OptimalAN,
  title={Optimal and Naive Diversification in Currency Markets},
  author={Fabian Ackermann and Walt Pohl and Karl Schmedders},
  journal={International Political Economy: Monetary Relations eJournal},
  year={2017}
}
DeMiguel, Garlappi, and Uppal (Review of Financial Studies, 22 (2009), 1915-1953) showed that in the stock market, it is difficult for an optimized portfolio constructed using mean-variance analysis to outperform a simple equally-weighted portfolio because of estimation error. In this paper, we demonstrate that portfolio optimization can be made to work in currency markets. The key difference between the two settings is that in currency markets interest rates provide a predictor of future… 
View on SSRN
doi.org
32 Citations
Highly Influential Citations
6
Background Citations
13
Methods Citations
4
Results Citations
5

32 Citations

Citation Type

Citation Type

Market Timing and Predictability in FX Markets
We study the economic value of market timing in FX markets, i.e., using information about the conditional Sharpe ratio to adjust the notional value of a conditionally mean-variance efficient…
Global Equity Investing: An Efficient Frontier Approach
The goal of this paper is to test empirically whether emerging-market portfolios appear on the meanvariance efficient frontier, investigate whether particular markets provide better diversification…
Ambiguity and the Home Currency Bias
This paper addresses the question of optimal currency exposure for a risk-and-ambiguity-averse international investor. A robust mean-variance model with smooth ambiguity preferences is used to derive…
Optimal currency hedge and the carry trade
This paper aims to investigate the efficiency of different hedging strategies for an investor holding a portfolio of foreign currency bonds.,The simplest strategies of no hedge and fully hedged are…
Importance of Transaction Costs for Asset Allocations in FX Markets
Taking transaction costs into account in a mean-variance portfolio optimization in FX markets significantly improves the after cost Sharpe ratio out-of-sample. The optimization reduces trading costs…
Pricing Implications of Covariances and Spreads in Currency Markets
We introduce a covariance and spread (i.e., exchange rate forward discount) adjusted carry factor that prices the cross-section of FX market returns, where many other single- and multifactor models…
Ambiguity, Optimal Currency Overlay, and Home Currency Bias
This paper addresses the problem of determining an optimal currency allocation for a risk-and-ambiguity-averse international investor. A robust mean-variance model with smooth ambiguity preferences…
Pricing Currency Risks
The currency market features a relatively small cross-section and conditional expected returns can be characterized by only a few signals – interest differentials, trend, and mean-reversion. We…
Dynamic Currency Hedging with Ambiguity
This paper establishes a general relation between investor's ambiguity and non-Gaussianity of financial asset returns. Based on that relation and utilizing a flexible non-Gaussian returns model for…
Effects of Quantitative Easing on Financial Market Integration and Hedging Efficacy
This thesis consists of three essays. The first essay (chapter 2) examines the correlations between bond markets, stock markets and currency forwards during the quantitative easing (QE) programs…
...
...

References

SHOWING 1-10 OF 23 REFERENCES
Optimal Versus Naive Diversification: How Inefficient is the 1/N Portfolio Strategy?
We evaluate the out-of-sample performance of the sample-based mean-variance model, and its extensions designed to reduce estimation error, relative to the naive 1-N portfolio. Of the 14 models we…
An Economic Evaluation of Empirical Exchange Rate Models
This paper provides a comprehensive evaluation of the short-horizon predictive ability of economic fundamentals and forward premia on monthly exchange rate returns in a framework that allows for…
Optimal Portfolio Choice with Parameter Uncertainty
Abstract In this paper, we analytically derive the expected loss function associated with using sample means and the covariance matrix of returns to estimate the optimal portfolio. Our analytical…
Option-Implied Currency Risk Premia
We obtain ex ante estimates of risk premia for G10 currency pairs using cross-sectional data on exchange rate options. Option prices are well-matched by a non-Gaussian, two-factor model, consistent…
Global Portfolio Optimization for BSE Sensex using the Enhanced Black Litterman Model
The Carry Trade: Risks and Drawdowns
We examine carry trade returns formed from the G10 currencies. Performance attributes depend on the base currency. Dynamically spread-weighting and risk-rebalancing positions improves performance.…
Do Peso Problems Explain the Returns to the Carry Trade?
We study the properties of the carry trade, a currency speculation strategy in which an investor borrows low-interest-rate currencies and lends high-interest-rate currencies. This strategy generates…
Currency Carry Trade Regimes: Beyond the Fama Regression
Forecasting Volatility in Financial Markets: A Review
Financial market volatility is an important input for investment, option pricing, and financial market regulation. The emphasis of this review article is on forecasting instead of modelling; it…
Crash-Neutral Currency Carry Trades
Currency carry trades exploiting violations of uncovered interest rate parity in G10 currencies deliver significant excess returns with annualized Sharpe ratios equal to or greater than those of…
...
...