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International Diversification Benefits with Foreign Exchange Investment Styles

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  • Tim A. Kroencke
  • Felix Schindler
  • Andreas Schrimpf

Abstract

Style-based management of the foreign exchange (FX) component of international investments with carry trade, FX momentum, and FX value strategies provides economically large and significant diversification benefits. These speculative benefits go beyond the hedging benefits of FX risk documented in the earlier literature. Our results hold after transaction costs and are confirmed in an extensive out-of-sample experiment mimicking investor decisions in real time. Adding a composite FX style portfolio to diversified allocations of global bonds and stocks leads to a 64% increase in the out-of-sample Sharpe ratio from 0.64 to 1.05, without adverse impact on other portfolio characteristics such as skewness.

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  • Tim A. Kroencke & Felix Schindler & Andreas Schrimpf, 2014. "International Diversification Benefits with Foreign Exchange Investment Styles," Review of Finance, European Finance Association, vol. 18(5), pages 1847-1883.
    • Handle: RePEc:oup:revfin:v:18:y:2014:i:5:p:1847-1883.
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    Cited by:

    1. Yamani, Ehab, 2019. "Diversification role of currency momentum for carry trade: Evidence from financial crises," Journal of Multinational Financial Management, Elsevier, vol. 49(C), pages 1-19.
    2. Balbás de la Corte, Alejandro & Laborda Herrero, Ricardo, 2017. "Interest Rate Future Quality Options and Negative Interest Rates," INDEM - Working Paper Business Economic Series 24859, Instituto para el Desarrollo Empresarial (INDEM).
    3. Fernandez-Perez, Adrian & Fuertes, Ana-Maria & Miffre, Joëlle, 2019. "A comprehensive appraisal of style-integration methods," Journal of Banking & Finance, Elsevier, vol. 105(C), pages 134-150.
    4. Huichou Huang & Lukas Menkhoff, 2018. "Global Positioning Risk and FX Trading Strategies," GRU Working Paper Series GRU_2018_020, City University of Hong Kong, Department of Economics and Finance, Global Research Unit.
    5. Ivan Petzev & Andreas Schrimpf & Alexander F. Wagner, 2015. "Has the Pricing of Stocks Become More Global?," Swiss Finance Institute Research Paper Series 15-48, Swiss Finance Institute, revised Apr 2016.
    6. Sakemoto, Ryuta, 2018. "Do precious and industrial metals act as hedges and safe havens for currency portfolios?," Finance Research Letters, Elsevier, vol. 24(C), pages 256-262.
    7. Malliaris, A.G. & Malliaris, Mary, 2011. "Are foreign currency markets interdependent? evidence from data mining technologies," MPRA Paper 35261, University Library of Munich, Germany.
    8. Vanja Piljak & Laurens Swinkels, 2017. "Fundamental indexation for developed, emerging, and frontier government bond markets," Journal of Asset Management, Palgrave Macmillan, vol. 18(5), pages 405-420, September.
    9. Lukas Menkhoff & Lucio Sarno & Maik Schmeling & Andreas Schrimpf, 2017. "Currency Value," Review of Financial Studies, Society for Financial Studies, vol. 30(2), pages 416-441.
    10. Bent Jesper Christensen & Rasmus T. Varneskov, 2016. "Dynamic Global Currency Hedging," CREATES Research Papers 2016-03, Department of Economics and Business Economics, Aarhus University.
    11. Laborda, Ricardo, 2018. "Optimal combination of currency strategies," The North American Journal of Economics and Finance, Elsevier, vol. 43(C), pages 129-140.
    12. Dagfinn Rime & Andreas Schrimpf, 2013. "The anatomy of the global FX market through the lens of the 2013 Triennial Survey," BIS Quarterly Review, Bank for International Settlements, December.
    13. Raúl Álvarez del Castillo Penna & José Antonio Núñez Mora & Leovardo Mata Mata, 2018. "Foreign Exchange Strategies Performance," Remef - Revista Mexicana de Economía y Finanzas Nueva Época REMEF (The Mexican Journal of Economics and Finance), Instituto Mexicano de Ejecutivos de Finanzas, IMEF, vol. 13(2), pages 195-245, Abril-Jun.
    14. Eriksen, Jonas N., 2019. "Cross-sectional return dispersion and currency momentum," Journal of Empirical Finance, Elsevier, vol. 53(C), pages 91-108.
    15. Cenedese, Gino, 2015. "Safe haven currencies: a portfolio perspective," Bank of England working papers 533, Bank of England.

    More about this item

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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