International Diversification Benefits with Foreign Exchange Investment Styles

CREATES Research Paper No. 2011-10

51 Pages Posted: 21 Mar 2011 Last revised: 18 Dec 2012

See all articles by Tim Alexander Kroencke

Tim Alexander Kroencke

University of Neuchatel - Institute of Financial Analysis

Felix Schindler

Steinbeis University Berlin - Center for Real Estate Studies; ZEW – Leibniz Centre for European Economic Research - International Finance and Financial Management

Andreas Schrimpf

Bank for International Settlements (BIS) - Monetary and Economic Department

Date Written: August 23, 2011

Abstract

This paper studies portfolio choice with popular foreign exchange (FX) investment styles such as carry trades, FX momentum and FX value strategies. We go beyond the benefits from hedging to shed more light on the speculative component of currency investments. In particular, we are interested in the magnitude of diversification benefits due to the style-based management of the currency component of well-diversified international portfolios. Our results suggest that FX investment styles generate significant improvements in the asset allocation. These findings hold after taking into account transaction costs and when controlling for the FX risk inherent in the benchmark assets. Importantly, these results are also confirmed in an extensive out-of-sample experiment mimicking investor decisions in real-time.

The appendices for this paper are available at the following URL: http://ssrn.com/abstract=2189886

Keywords: International Diversification, Foreign Exchange Speculation and Hedging, Carry Trades, Stochastic Dominance, Investment Styles

JEL Classification: G11, G12, G15

Suggested Citation

Kroencke, Tim Alexander and Schindler, Felix and Schrimpf, Andreas, International Diversification Benefits with Foreign Exchange Investment Styles (August 23, 2011). CREATES Research Paper No. 2011-10. Available at SSRN: https://ssrn.com/abstract=1790764 or http://dx.doi.org/10.2139/ssrn.1790764

Tim Alexander Kroencke

University of Neuchatel - Institute of Financial Analysis ( email )

Pierre-a-Mazel,7
Neuchatel, CH-2000
Switzerland

Felix Schindler

Steinbeis University Berlin - Center for Real Estate Studies ( email )

Berlin
Germany

ZEW – Leibniz Centre for European Economic Research - International Finance and Financial Management ( email )

Postfach 103443
Mannheim, D-68034
Germany

Andreas Schrimpf (Contact Author)

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

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