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International portfolio selection with exchange rate risk: A behavioural portfolio theory perspective

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  • Jiang, Chonghui
  • Ma, Yongkai
  • An, Yunbi

Abstract

This paper analyzes international portfolio selection with exchange rate risk based on behavioural portfolio theory (BPT). We characterize the conditions under which the BPT problem with a single foreign market has an optimal solution, and show that the optimal portfolio contains the traditional mean–variance efficient portfolio without consideration of exchange rate risk, and an uncorrelated component constructed to hedge against exchange rate risk. We illustrate that the optimal portfolio must be mean–variance efficient with exchange rate risk, while the same is not true from the perspective of local investors unless certain conditions are satisfied. We further establish that international portfolio selection in the BPT with multiple foreign markets consists of two sequential decisions. Investors first select the optimal BPT portfolio in each market, overlooking covariances among markets, and then allocate funds across markets according to a specific rule to achieve mean–variance efficiency or to minimize the loss in efficiency.

Suggested Citation

  • Jiang, Chonghui & Ma, Yongkai & An, Yunbi, 2013. "International portfolio selection with exchange rate risk: A behavioural portfolio theory perspective," Journal of Banking & Finance, Elsevier, vol. 37(2), pages 648-659.
  • Handle: RePEc:eee:jbfina:v:37:y:2013:i:2:p:648-659 DOI: 10.1016/j.jbankfin.2012.10.004
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    Cited by:

    1. Pfiffelmann, Marie & Roger, Tristan & Bourachnikova, Olga, 2016. "When Behavioral Portfolio Theory meets Markowitz theory," Economic Modelling, Elsevier, vol. 53(C), pages 419-435.
    2. Alexander, Gordon J. & Baptista, Alexandre M. & Yan, Shu, 2017. "Portfolio selection with mental accounts and estimation risk," Journal of Empirical Finance, Elsevier, vol. 41(C), pages 161-186.

    More about this item

    Keywords

    International portfolio selection; Exchange rate risk; Behavioural portfolio theory; Mean–variance efficiency;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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