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International Portfolio Diversification: Short-Term Financial Assets and Gold

In: Exchange Rate Theory and Practice


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  • Jorge Braga de Macedo
  • Jeffrey Goldstein
  • David Meerschwam


Using a continuous-time finance-theoretic framework, this paper presents the optimal portfolio rule of an international investor who consumes N national composite goods and who holds N domestic-currency-denominated assets with known nominal interest rates in an environment where prices of goods, assets and exchange rates follow geometric Brownian motion. It is shown that the currency portfolio rule described in Macedo (1982a) is applicable to the case where there are N assets with a known price and one asset, gold, with a random rice in terms of the numeraire. Under these assumptions, it is found that the optimal portfolio of an investor consuming goods from all major industrialized countries (according to their weight in total trade) would be dominated in March 1981 by long positions in U.S. dollars (25%), yen (17%), D. marks (16%), French francs (15%) and pounds sterling (10%). An investor consuming only U.S. goods, by contrast, would hold 96% of his optimal portfolio in U.S. dollars. Because of the covariance of exchange rates and gold, the exclusion of the latter generates substantial reshuffling. The analysis of the evolution of portfolios over time shows that shares changed dramatically at the beginning of the period and did not begin to approach their March 1981 values until the end of 1975. In the case of the yen and the pound there were oscillations throughout the period. With respect to the dollar share in the optimal portfolio of the U.S. and international investor, it is found that, in the period between late 1974 and mid-1976, a period in which the dollar is considered to have been "strong", a large decline in its optimal share took place.

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This chapter was published in:

  • John F. O. Bilson & Richard C. Marston, 1984. "Exchange Rate Theory and Practice," NBER Books, National Bureau of Economic Research, Inc, number bils84-1, October.
    This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 6836.

    Handle: RePEc:nbr:nberch:6836

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    Cited by:
    1. François Renard & Michel Boutillier & Camille Baulant, 1992. "Taux d'intérêt et comportements spéculatifs sur le marché du franc français," Économie et Prévision, Programme National Persée, Programme National Persée, vol. 106(5), pages 97-108.
    2. Nicolas Coeurdacier & Hélène Rey, 2013. "Home Bias in Open Economy Financial Macroeconomics," Journal of Economic Literature, American Economic Association, vol. 51(1), pages 63-115, March.
    3. van Wincoop, Eric & Warnock, Francis E., 2010. "Can trade costs in goods explain home bias in assets?," Journal of International Money and Finance, Elsevier, Elsevier, vol. 29(6), pages 1108-1123, October.
    4. Tille, Cédric & van Wincoop, Eric, 2010. "International capital flows," Journal of International Economics, Elsevier, Elsevier, vol. 80(2), pages 157-175, March.
    5. Eric van Wincoop & Francis E. Warnock, 2006. "Is Home Bias in Assets Related to Home Bias in Goods?," NBER Working Papers 12728, National Bureau of Economic Research, Inc.
    6. Bratsiotis, George J. & Robinson, Wayne, 2005. "Currency composition of debt, risk premia and the 1997 Korean crisis," Economic Modelling, Elsevier, Elsevier, vol. 22(3), pages 459-471, May.


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