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Correlation Risk and International Portfolio Choice

53 Pages Posted: 8 Apr 2016  

Nicole Branger

University of Muenster - Finance Center Muenster

Matthias Muck

University of Bamberg

Stefan Weisheit

University of Bamberg

Date Written: April 6, 2016

Abstract

We study the optimal portfolio choice of international investors when variances and correlations are stochastic. We assume that the returns from the perspective of the domestic investor are driven by a Wishart Affine Stochastic Correlation (WASC) model. We show that this also holds from the perspective of the foreign investor and give the relations between the variance-covariance matrices and the parameters of its dynamics in both currencies. Stochastic second moments have an impact on risk and returns that characterize the domestic and the foreign investment opportunity sets. Optimal portfolios and hedging demands of international investors differ due to their dependence on exchange rate variances and correlations. The benefits from investing can be different for domestic and foreign investors, and can also react differently to changes in second moments. These findings hold both in complete and incomplete markets.

Keywords: International asset allocation, stochastic correlation, Wishart process, intertemporal hedging demand, diversification benefits

JEL Classification: G11, G13

Suggested Citation

Branger, Nicole and Muck, Matthias and Weisheit, Stefan, Correlation Risk and International Portfolio Choice (April 6, 2016). Available at SSRN: https://ssrn.com/abstract=2759890 or http://dx.doi.org/10.2139/ssrn.2759890

Nicole Branger

University of Muenster - Finance Center Muenster ( email )

Universitatsstr. 14-16
Muenster, 48143
Germany
+49 251 83 29779 (Phone)
+49 251 83 22867 (Fax)

HOME PAGE: http://www.wiwi.uni-muenster.de/fcm/fcm/das-finance-center/details.php?weobjectID=162

Matthias Muck

University of Bamberg ( email )

Kärntenstr. 7
Bamberg, 96052
Germany
+49-(0)951-860-2091 (Phone)

Stefan Weisheit (Contact Author)

University of Bamberg ( email )

Kärntenstr. 7
Bamberg, 96052
Germany
+49 951 / 863 2091 (Phone)

HOME PAGE: http://www.uni-bamberg.de/bwl-bfc/

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