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Robust international portfolio management

Author

Listed:
  • Raquel Fonseca

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  • Wolfram Wiesemann
  • Berç Rustem

Abstract

We present an international portfolio optimization model where we take into account the two different sources of return of an international asset: the local returns denominated in the local currency, and the returns on the foreign exchange rates. The explicit consideration of the returns on exchange rates introduces non-linearities in the model, both in the objective function (return maximization) and in the triangulation requirement of the foreign exchange rates. The uncertainty associated with both types of returns is incorporated directly in the model by the use of robust optimization techniques. We show that, by using appropriate assumptions regarding the formulation of the uncertainty sets, the proposed model has a semidefinite programming formulation and can be solved efficiently. While robust optimization provides a guaranteed minimum return inside the uncertainty set considered, we also discuss an extension of our formulation with additional guarantees through trading in quanto options for the foreign assets and in equity options for the domestic assets.
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Suggested Citation

  • Raquel Fonseca & Wolfram Wiesemann & Berç Rustem, 2012. "Robust international portfolio management," Computational Management Science, Springer, vol. 9(1), pages 31-62, February.
  • Handle: RePEc:spr:comgts:v:9:y:2012:i:1:p:31-62 DOI: 10.1007/s10287-011-0132-0
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    References listed on IDEAS

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    1. Glen A. Larsen, Jr. & Bruce G. Resnick, 2000. "The Optimal Construction of Internationally Diversified Equity Portfolios Hedged Against Exchange Rate Uncertainty," European Financial Management, European Financial Management Association, vol. 6(4), pages 479-514.
    2. Steil, Benn, 1993. "Currency Options and the Optimal Hedging of Contingent Foreign Exchange Exposure," Economica, London School of Economics and Political Science, vol. 60(240), pages 413-431, November.
    3. Zymler, Steve & Rustem, Berç & Kuhn, Daniel, 2011. "Robust portfolio optimization with derivative insurance guarantees," European Journal of Operational Research, Elsevier, vol. 210(2), pages 410-424, April.
    4. Rustem, Berc, 1995. "Computing optimal multi-currency mean-variance portfolios," Journal of Economic Dynamics and Control, Elsevier, vol. 19(5-7), pages 901-908.
    5. Raquel J. Fonseca & Steve Zymler & Wolfram Wiesemann & Berc Rustem, 2009. "Robust Optimization of Currency Portfolios," Working Papers 012, COMISEF.
    6. Levy, Haim & Sarnat, Marshall, 1970. "International Diversification of Investment Portfolios," American Economic Review, American Economic Association, pages 668-675.
    7. T. S. Ho & Richard C. Stapleton & Marti G. Subrahmanyam, 1995. "Correlation risk, cross-market derivative products and portfolio performance," European Financial Management, European Financial Management Association, vol. 1(2), pages 105-124.
    8. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, March.
    9. Glen, Jack & Jorion, Philippe, 1993. " Currency Hedging for International Portfolios," Journal of Finance, American Finance Association, vol. 48(5), pages 1865-1886, December.
    10. Isabelle Huault & V. Perret & S. Charreire-Petit, 2007. "Management," Post-Print halshs-00337676, HAL.
    11. Topaloglou, Nikolas & Vladimirou, Hercules & Zenios, Stavros A., 2008. "A dynamic stochastic programming model for international portfolio management," European Journal of Operational Research, Elsevier, vol. 185(3), pages 1501-1524, March.
    12. Shawky, Hany A. & Kuenzel, Rolf & Mikhail, Azmi D., 1997. "International portfolio diversification: a synthesis and an update," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 7(4), pages 303-327, December.
    13. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    14. Eun, Cheol S & Resnick, Bruce G, 1988. " Exchange Rate Uncertainty, Forward Contracts, and International Portfolio Selection," Journal of Finance, American Finance Association, vol. 43(1), pages 197-215, March.
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    Cited by:

    1. Jun-ya Gotoh & Akiko Takeda, 2011. "On the role of norm constraints in portfolio selection," Computational Management Science, Springer, pages 323-353.
    2. Fonseca, Raquel J. & Rustem, Berç, 2012. "International portfolio management with affine policies," European Journal of Operational Research, Elsevier, vol. 223(1), pages 177-187.

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