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International Diversification Benefits with Foreign Exchange Investment Styles

Author

Listed:
  • Tim A. Kroencke

    () (Centre for European Economic Research (ZEW))

  • Felix Schindler

    () (Centre for European Economic Research (ZEW) and Steinbeis University Berlin)

  • Andreas Schrimpf

    () (Aarhus University and CREATES)

Abstract

This paper provides a comprehensive analysis of portfolio choice with popular foreign exchange (FX) investment styles such as carry trades and strategies commonly known as FX momentum, and FX value. We investigate if diversification benefits can be achieved by style investing in FX markets relative to a benchmark allocation consisting of U.S. bonds, U.S. stocks, and international stocks. Overall, our results suggest that there are significant improvements in international portfolio diversification due to stylebased investing in FX markets (both in the statistical, and most importantly, in the economic sense). These results prevail for the most important investment styles after accounting for transaction costs due to re-balancing of currency positions, and also hold in out-of-sample tests. Moreover, these gains do not only apply to a mean-variance investor but we also show that international portfolios augmented by FX investment styles are superior in terms of second and third order stochastic dominance. Thus, even an investor who dislikes negatively skewed return distributions would prefer a portfolio augmented by FX investment styles compared to the benchmark.

Suggested Citation

  • Tim A. Kroencke & Felix Schindler & Andreas Schrimpf, 2011. "International Diversification Benefits with Foreign Exchange Investment Styles," CREATES Research Papers 2011-10, Department of Economics and Business Economics, Aarhus University.
  • Handle: RePEc:aah:create:2011-10
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    File URL: ftp://ftp.econ.au.dk/creates/rp/11/rp11_10.pdf
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    References listed on IDEAS

    as
    1. de Roon, F.A. & Nijman, T.E. & Werker, B.J.M., 1998. "Testing for mean-variance spanning with short sales constraints and transaction costs : The case of emerging markets," Discussion Paper 1998-07, Tilburg University, Center for Economic Research.
    2. de Roon, Frans A. & Nijman, Theo E. & Werker, Bas J. M., 2003. "Currency hedging for international stock portfolios: The usefulness of mean-variance analysis," Journal of Banking & Finance, Elsevier, vol. 27(2), pages 327-349, February.
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    Citations

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    Cited by:

    1. Petzev, Ivan & Schrimpf, Andreas & Wagner, Alexander F, 2015. "Has the Pricing of Stocks Become More Global?," CEPR Discussion Papers 10966, C.E.P.R. Discussion Papers.
    2. Cenedese, Gino, 2015. "Safe haven currencies: a portfolio perspective," Bank of England working papers 533, Bank of England.
    3. repec:oup:rfinst:v:30:y:2017:i:2:p:416-441. is not listed on IDEAS
    4. 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.
    5. Laborda Herrero, Ricardo & Balbas de la Corte, Alejandro, 2017. "Interest Rate Future Quality Options and Negative Interest Rates," INDEM - Working Paper Business Economic Series 24859, Instituto para el Desarrollo Empresarial (INDEM).
    6. repec:eee:ecofin:v:43:y:2018:i:c:p:129-140 is not listed on IDEAS
    7. 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.
    8. Malliaris, A.G. & Malliaris, Mary, 2011. "Are foreign currency markets interdependent? evidence from data mining technologies," MPRA Paper 35261, University Library of Munich, Germany.
    9. Bent Jesper Christensen & Rasmus T. Varneskov, 2016. "Dynamic Global Currency Hedging," CREATES Research Papers 2016-03, Department of Economics and Business Economics, Aarhus University.
    10. repec:pal:assmgt:v:18:y:2017:i:5:d:10.1057_s41260-017-0045-8 is not listed on IDEAS

    More about this item

    Keywords

    International Diversification; Foreign Exchange Speculation and Hedging; Carry Trades; Stochastic Dominance; Investment Styles;

    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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