IDEAS home Printed from https://ideas.repec.org/p/arx/papers/1611.01463.html
   My bibliography  Save this paper

International Portfolio Optimisation with Integrated Currency Overlay Costs and Constraints

Author

Listed:
  • Nonthachote Chatsanga
  • Andrew J. Parkes

Abstract

Portfolio optimisation typically aims to provide an optimal allocation that minimises risk, at a given return target, by diversifying over different investments. However, the potential scope of such risk diversification can be limited if investments are concentrated in only one country, or more specifically one currency. Multi-currency portfolio is an alternative to achieve higher returns and more diversified portfolios but it requires a careful management of the entailed risks from changes in exchange rates. The deviation between asset and currency exposures in a portfolio is defined as the "currency overlay". This paper addresses risk mitigation by allowing currency overlay and asset allocation be optimised together. We propose a model of the international portfolio optimisation problem in which the currency overlay is constructed by holding foreign exchange rate forward contracts. Crucially, the cost of carry, transaction costs, and margin requirement of forward contracts are also taken into account in portfolio return calculation. This novel extension of previous overlay models improves the accuracy of risk and return calculation of portfolios; furthermore, our experimental results show that inclusion of such costs significantly changes the optimal decisions. Effects of constraints imposed to reduce transaction costs associated are examined and the empirical results show that risk-return compensation of portfolios varies significantly with different return targets.

Suggested Citation

  • Nonthachote Chatsanga & Andrew J. Parkes, 2016. "International Portfolio Optimisation with Integrated Currency Overlay Costs and Constraints," Papers 1611.01463, arXiv.org.
    • Handle: RePEc:arx:papers:1611.01463
    as

    Download full text from publisher

    File URL: http://arxiv.org/pdf/1611.01463
    File Function: Latest version
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Glen A. Larsen, Jr. & Bruce G. Resnick, 2000. "The Optimal Construction of Internationally Diversified Equity Portfolios Hedged Against Exchange Rate Uncertainty," European Financial Management, European Financial Management Association, vol. 6(4), pages 479-514, December.
    2. Raquel J. Fonseca & Steve Zymler & Wolfram Wiesemann & Berc Rustem, 2009. "Robust Optimization of Currency Portfolios," Working Papers 012, COMISEF.
    3. Levy, Haim & Sarnat, Marshall, 1970. "International Diversification of Investment Portfolios," American Economic Review, American Economic Association, vol. 60(4), pages 668-675, September.
    4. Andrea Beltratti & Andrea Consiglio & Stavros Zenios, 1999. "Scenario modeling for the management ofinternational bond portfolios," Annals of Operations Research, Springer, vol. 85(0), pages 227-247, January.
    5. Robert A. JARROW & George S. OLDFIELD, 2008. "Forward Contracts And Futures Contracts," World Scientific Book Chapters, in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 11, pages 237-246, World Scientific Publishing Co. Pte. Ltd..
    6. Miguel Lobo & Maryam Fazel & Stephen Boyd, 2007. "Portfolio optimization with linear and fixed transaction costs," Annals of Operations Research, Springer, vol. 152(1), pages 341-365, July.
    7. Topaloglou, Nikolas & Vladimirou, Hercules & Zenios, Stavros A., 2002. "CVaR models with selective hedging for international asset allocation," Journal of Banking & Finance, Elsevier, vol. 26(7), pages 1535-1561, July.
    8. repec:bla:jfinan:v:43:y:1988:i:1:p:197-215 is not listed on IDEAS
    9. Korajczyk, Robert A, 1985. "The Pricing of Forward Contracts for Foreign Exchange," Journal of Political Economy, University of Chicago Press, vol. 93(2), pages 346-368, April.
    10. Lin, Chang-Chun & Liu, Yi-Ting, 2008. "Genetic algorithms for portfolio selection problems with minimum transaction lots," European Journal of Operational Research, Elsevier, vol. 185(1), pages 393-404, February.
    11. Glen, Jack & Jorion, Philippe, 1993. "Currency Hedging for International Portfolios," Journal of Finance, American Finance Association, vol. 48(5), pages 1865-1886, December.
    12. Topaloglou, Nikolas & Vladimirou, Hercules & Zenios, Stavros A., 2008. "A dynamic stochastic programming model for international portfolio management," European Journal of Operational Research, Elsevier, vol. 185(3), pages 1501-1524, March.
    13. Roll, Richard, 1984. "A Simple Implicit Measure of the Effective Bid-Ask Spread in an Efficient Market," Journal of Finance, American Finance Association, vol. 39(4), pages 1127-1139, September.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Nonthachote Chatsanga & Andrew J. Parkes, 2017. "Two-Stage Stochastic International Portfolio Optimisation under Regular-Vine-Copula-Based Scenarios," Papers 1704.01174, arXiv.org.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Raquel Fonseca & Wolfram Wiesemann & Berç Rustem, 2012. "Robust international portfolio management," Computational Management Science, Springer, vol. 9(1), pages 31-62, February.
    2. Raquel J. Fonseca & Steve Zymler & Wolfram Wiesemann & Berc Rustem, 2009. "Robust Optimization of Currency Portfolios," Working Papers 012, COMISEF.
    3. Topaloglou, Nikolas & Vladimirou, Hercules & Zenios, Stavros A., 2008. "A dynamic stochastic programming model for international portfolio management," European Journal of Operational Research, Elsevier, vol. 185(3), pages 1501-1524, March.
    4. Mansini, Renata & Ogryczak, Wlodzimierz & Speranza, M. Grazia, 2014. "Twenty years of linear programming based portfolio optimization," European Journal of Operational Research, Elsevier, vol. 234(2), pages 518-535.
    5. Mei Qiu & Pinfold & Rose, 2015. "A currency preferential approach to international equity investment," Applied Economics, Taylor & Francis Journals, vol. 47(49), pages 5247-5261, October.
    6. McDowell, Shaun, 2018. "An empirical evaluation of estimation error reduction strategies applied to international diversification," Journal of Multinational Financial Management, Elsevier, vol. 44(C), pages 1-13.
    7. Fonseca, Raquel J. & Rustem, Berç, 2012. "International portfolio management with affine policies," European Journal of Operational Research, Elsevier, vol. 223(1), pages 177-187.
    8. Andrea Beltratti & Paolo Colla, 2007. "A portfolio-based evaluation of affine term structure models," Annals of Operations Research, Springer, vol. 151(1), pages 193-222, April.
    9. Burkhardt, Raphael & Ulrych, Urban, 2023. "Sparse and stable international portfolio optimization and currency risk management," Journal of International Money and Finance, Elsevier, vol. 139(C).
    10. Kai Li & Asani Sarkar & Zhenyu Wang, 1999. "Assessing the impact of short-sale constraints on the gains from international diversification," Staff Reports 89, Federal Reserve Bank of New York.
    11. Adrian Gepp & Geoff Harris & Bruce Vanstone, 2020. "Financial applications of semidefinite programming: a review and call for interdisciplinary research," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 60(4), pages 3527-3555, December.
    12. Garry J. Twite, 1998. "The Pricing of Australian Index Futures Contracts with Taxes and Transaction Costs," Australian Journal of Management, Australian School of Business, vol. 23(1), pages 57-81, June.
    13. Borgsen, Sina & Glaser, Markus, 2005. "Diversifikationseffekte durch small und mid caps? : Eine empirische Untersuchung basierend auf europäischen Aktienindizes," Papers 05-10, Sonderforschungsbreich 504.
    14. Borgsen, Sina & Glaser, Markus, 2005. "Diversifikationseffekte durch Small und Mid Caps?," Sonderforschungsbereich 504 Publications 05-10, Sonderforschungsbereich 504, Universität Mannheim;Sonderforschungsbereich 504, University of Mannheim.
    15. Jörgen Blomvall & Jonas Ekblom, 2018. "Corporate hedging: an answer to the “how” question," Annals of Operations Research, Springer, vol. 266(1), pages 35-69, July.
    16. Davide Lauria & W. Brent Lindquist & Svetlozar T. Rachev, 2023. "Enhancing CVaR portfolio optimisation performance with GAM factor models," Papers 2401.00188, arXiv.org.
    17. Sun, Qi & Dong, Yucheng & Xu, Weidong, 2013. "Effects of higher order moments on the newsvendor problem," International Journal of Production Economics, Elsevier, vol. 146(1), pages 167-177.
    18. Jonathan Fletcher & Elizabeth Littlejohn & Andrew Marshall, 2023. "Exploring the performance of US international bond mutual funds," The Financial Review, Eastern Finance Association, vol. 58(4), pages 765-782, November.
    19. Libo Yin & Liyan Han, 2013. "Options strategies for international portfolios with overall risk management via multi-stage stochastic programming," Annals of Operations Research, Springer, vol. 206(1), pages 557-576, July.
    20. Grobys, Klaus, 2024. "A universal exponent governing foreign exchange rate risks," International Review of Financial Analysis, Elsevier, vol. 95(PB).

    More about this item

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:arx:papers:1611.01463. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: arXiv administrators (email available below). General contact details of provider: http://arxiv.org/ .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.