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Performance of currency portfolios chosen by a Bayesian technique: 1967-1985

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  • Dumas, Bernard

Abstract

The hypothesis being tested in this article is that participants in the foreign exchange market are improperly diversified across currencies. If this type of inefficiency were to be verified, it could constitute an explanation of the large volatility of exchange rates: traders who do not fully exploit the potential for diversification unnecessarily restrict the sizes of the positions they do take in the individual currencies, generate thereby a shortage of speculative interest, and, as a consequence, stabilize exchange rates less than they otherwise would. In order to test the hypothesis, a number of implementable portfolio diversification policies are tried out on a large body of data covering nine major currencies and eighteen years of weekly observations. While some policies do produce abnormal returns (over and beyond proper reward for risk), none does so in a statistically significant way. This means that the evidence does not allow one to conclude that market participants are improperly diversified. As a byproduct of this investigation, techniques are found which would allow portfolio managers to earn a proper reward for risk by following a purely mechanical procedure; such techniques may be valuable in a multi-country world where the aggregate portfolio of currencies and securities is unknown and is not supposed to be efficient.
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  • Dumas, Bernard, 1990. "Performance of currency portfolios chosen by a Bayesian technique: 1967-1985," Journal of Banking & Finance, Elsevier, vol. 14(2-3), pages 539-558, August.
    • Handle: RePEc:eee:jbfina:v:14:y:1990:i:2-3:p:539-558
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    Cited by:

    1. Jondeau, E. & Rockinger, M., 2002. "Asset Allocation in Transition Economies," Working papers 90, Banque de France.
    2. Ando, Tomohiro, 2009. "Bayesian portfolio selection using a multifactor model," International Journal of Forecasting, Elsevier, vol. 25(3), pages 550-566, July.
    3. Srichander Ramaswamy, 1997. "Global asset allocation in fixed income markets," BIS Working Papers 46, Bank for International Settlements.
    4. Sweeney, Richard J., 2006. "Mean Reversion in G-10 Nominal Exchange Rates," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 41(3), pages 685-708, September.
    5. Detlef Seese & Christof Weinhardt & Frank Schlottmann (ed.), 2008. "Handbook on Information Technology in Finance," International Handbooks on Information Systems, Springer, number 978-3-540-49487-4, November.

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