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Abstract

We draw on portfolio theory and international diversification in order to analyse strategies allowing to reduce emerging economies' exposure to exchange-rate risk. We show in particular that it may be efficient for an investor, in terms of maximising the return-to-risk ratio, to build up a portfolio of emerging-country assets denominated in local currency - unhedged against currency risk - compared with a strategy including emerging-country securities denominated in foreign currencies. This strategy would lead to a reduction in the original sin (i.e. the inability of emerging economies to borrow in local currency), and de facto to a reduction in currency mismatches in the balance sheets of emerging economies.

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File URL: http://hal.archives-ouvertes.fr/docs/00/64/56/30/PDF/CR09-EFI_04.pdf
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Paper provided by HAL in its series Working Papers with number hal-00616581.

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Date of creation: 15 Mar 2009
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Handle: RePEc:hal:wpaper:hal-00616581

Note: View the original document on HAL open archive server: http://hal.archives-ouvertes.fr/hal-00616581/en/
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Related research

Keywords: International portfolio diversification; Original Sin; Emerging countries; Downside risk;

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Find related papers by JEL classification:

• G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
• E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
• F34 - International Economics - - International Finance - - - International Lending and Debt Problems

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1. Barry Eichengreen & Ricardo Hausmann & Ugo Panizza, 2007. "Currency Mismatches, Debt Intolerance, and the Original Sin: Why They Are Not the Same and Why It Matters," NBER Chapters, in: Capital Controls and Capital Flows in Emerging Economies: Policies, Practices and Consequences, pages 121-170 National Bureau of Economic Research, Inc.
2. John D. Burger & Francis E. Warnock, 2006. "Foreign Participation in Local Currency Bond Markets," NBER Working Papers 12548, National Bureau of Economic Research, Inc.
   
   • Burger, John D. & Warnock, Francis E., 2007. "Foreign participation in local currency bond markets," Review of Financial Economics, Elsevier, vol. 16(3), pages 291-304.
   • John D. Burger & Francis E. Warnock, 2004. "Foreign participation in local-currency bond markets," International Finance Discussion Papers 794, Board of Governors of the Federal Reserve System (U.S.).
3. Hwang, Soosung & Pedersen, Christian S., 2004. "Asymmetric risk measures when modelling emerging markets equities: evidence for regional and timing effects," Emerging Markets Review, Elsevier, vol. 5(1), pages 109-128, March.
4. Harlow, W. V. & Rao, Ramesh K. S., 1989. "Asset Pricing in a Generalized Mean-Lower Partial Moment Framework: Theory and Evidence," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 24(03), pages 285-311, September.
5. Matus Medo & Chi Ho Yeung & Yi-Cheng Zhang, 2008. "How to quantify the influence of correlations on investment diversification," Papers 0805.3397, arXiv.org, revised Feb 2009.
6. Campbell, Rachel A. & Kräussl, Roman, 2007. "Revisiting the home bias puzzle: downside equity risk," Open Access publications from Maastricht University urn:nbn:nl:ui:27-19569, Maastricht University.
   
   • Campbell, Rachel A. & Kraussl, Roman, 2007. "Revisiting the home bias puzzle: Downside equity risk," Journal of International Money and Finance, Elsevier, vol. 26(7), pages 1239-1260, November.
   • Rachel A. Campbell & Roman Kräussl, 2006. "Revisiting the Home Bias Puzzle. Downside Equity Risk," CFS Working Paper Series 2006/31, Center for Financial Studies.

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