Let the Parametric Phoenix Fly

41 Pages Posted: 18 Jul 2019

See all articles by Pedro Barroso

Pedro Barroso

CATÓLICA-LISBON School of Business & Economics

Jurij-Andrei Reichenecker

Hochschule Liechtenstein - Institute of Financial Services

Michael R. Reichenecker

UBS AG

Date Written: July 17, 2019

Abstract

In international portfolios investors move away from domestic-only investing and diversify their allocation of assets by foreign equities. The exposure to foreign currencies adds an additional risk component which is managed in the currency overlay. To achieve an ideal weighting of the allocation of assets and the exposure to currencies, this study proposes a novel approach for a joint optimization. For the optimal weighting of equities we suggest to employ characteristics of momentum, value, and size strategies while currencies are allocated according to characteristics of carry trade, currency momentum, and currency value strategies. Relative to a benchmark and in an out-of-sample setting, we document an increase in the portfolios’ Sharpe ratio by 30% after transaction and rebalancing costs. This relative improvement is primarily driven by the increase in portfolios’ returns, while the portfolios’ overall volatility remains unaffected.

Keywords: asset allocation, currency overlay, portfolio choice, portfolio optimization

JEL Classification: F31, G11, G15

Suggested Citation

Barroso, Pedro and Reichenecker, Jurij-Andrei and Reichenecker, Michael R., Let the Parametric Phoenix Fly (July 17, 2019). Available at SSRN: https://ssrn.com/abstract=3421686 or http://dx.doi.org/10.2139/ssrn.3421686

Pedro Barroso

CATÓLICA-LISBON School of Business & Economics ( email )

Palma de Cima
Lisbon, Lisboa 1649-023
Portugal

HOME PAGE: http://https://clsbe.lisboa.ucp.pt/person/pedro-monteiro-e-silva-barroso

Jurij-Andrei Reichenecker (Contact Author)

Hochschule Liechtenstein - Institute of Financial Services ( email )

Liechtenstein

Michael R. Reichenecker

UBS AG ( email )

Europastrasse 1
Opfikon
Zurich, CH-8152
Switzerland

HOME PAGE: http://www.ubs.com

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